Kentucky First Federal Bancorp 10-Q

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements Certain statements contained in this report that are not historical facts are forward-looking statements that are subject to certain risks and uncertainties. When used herein, the terms “anticipates,” “plans,” “expects,” “believes,” and similar expressions as they relate to Kentucky First Federal Bancorp or its management are intended to identify such forward-looking statements. Kentucky First Federal Bancorp’s actual results, performance or achievements may materially differ from those expressed or implied in the forward-looking statements. Risks and uncertainties that could cause or contribute to such material differences include, but are not limited to, general economic conditions, prices for real estate in the Company’s market areas, interest rate environment, competitive conditions in the financial services industry, changes in law, governmental policies and regulations, rapidly changing technology affecting financial services, the potential effects of the COVID-19 pandemic on the local and national economic environment, on our customers and on our operations (as well as any changes to federal, state and local government laws, regulations and orders in connection with the pandemic), and the other matters mentioned in Item 1A of the Company’s Annual Report on Form 10-K for the year ended June 30, 2022. Except as required by applicable law or regulation, the Company does not undertake the responsibility, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events. 24 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Average Balance Sheets The following table represents the average balance sheets for the three-month periods ended September 30, 2022 and 2021, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods. Three Months Ended September 30, 2022 2021 Average Balance Interest And Dividends Yield/ Cost Average Balance Interest And Dividends Yield/ Cost (Dollars in thousands) Interest-earning assets: Loans 1 $ 283,554 $ 2,644 3.73 % $ 298,174 $ 2,934 3.94 % Mortgage-backed securities 14,002 114 3.26 481 3 2.50 Other securities – – – – – – Other interest-earning assets 17,542 127 2.90 28,694 37 0.52 Total interest-earning assets 315,097 2,885 3.66 327,349 2,974 3.63 Less: Allowance for loan losses (1,545 ) (1,616 ) Non-interest-earning assets 12,029 11,566 Total assets $ 325,581 $ 337,299 Interest-bearing liabilities: Demand deposits $ 21,638 $ 11 0.20 % $ 19,970 $ 9 0.18 % Savings 75,593 102 0.54 70,123 68 0.39 Certificates of deposit 121,286 237 0.78 125,887 291 0.93 Total deposits 218,516 350 0.64 215,980 368 0.68 Borrowings 38,011 103 1.08 53,614 101 0.75 Total interest-bearing liabilities 256,527 453 0.71 269,594 469 0.69 Noninterest-bearing demand deposits 15,055 13,186 Noninterest-bearing liabilities 2,120 2,162 Total liabilities 273,702 284,942 Shareholders’ equity 51,879 52,357 Total liabilities and shareholders’ equity $ 325,581 $ 337,299 Net interest spread $ 2,432 2.96 % $ 2,505 2.94 % Net interest margin 3.09 % 3.06 % Average interest-earning assets to average interest-bearing liabilities 122.83 % 121.42 % 1 Includes loan fees, immaterial in amount, in both interest income and the calculation of yield on loans. Also includes loans on nonaccrual status. 25 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Discussion of Financial Condition Changes from June 30, 2022 to September 30, 2022 Risks and Uncertainties Related to COVID-19 - In March 2020 the World Health Organization determined that the spread of a new coronavirus, COVID-19, had risen to such a level as to constitute a worldwide pandemic. The spread of this virus has created a global public health crisis. Uncertainty related to the effects of the virus have disrupted financial markets, activity in all aspects of life including governmental, business and consumer routines and the markets in which the Company operates. In response to the crisis governmental authorities closed or limited the operations of many non-essential businesses and required various responses from individuals including stay-at-home restrictions and social distancing. These governmental restrictions, along with a fear of contracting the virus, have resulted in severe reduction of commercial and consumer activity, which is resulting in loss of revenues by businesses, a dramatic spike in unemployment, material decreases in oil and gas prices and in business valuations, disrupted global supply chains and market volatility. Management continues to monitor the general impact of COVID-19, as well as certain provisions of the Coronavirus Aid, Relief and Economic Security (“CARES”) Act, enacted on March 27, 2020, and other more recent legislative and regulatory relief efforts including the Consolidated Appropriations Act, 2021. Because the impact is contingent upon the duration and severity of the economic downturn, management cannot determine or estimate the magnitude of the impact at this time. While the pandemic has affected the physical operations of the Banks, the business has been mostly unchanged with consistent levels of consumer transactions and loan originations. The potential for a deterioration in asset quality remains, but actual asset quality has improved. Classified assets at September 30, 2021, totaled $8.5 million compared to $10.5 million at March 31, 2020. Management attributes some of this improved performance to the overall strengthening in the residential real estate market. Approximately 95% of the Company’s loans are secured by residential real estate. Business Continuity, Processes and Controls In response to the COVID-19 pandemic the Banks are considered essential businesses and have remained open for business. We implemented our pandemic preparedness plan and generally maintained regular business hours through drive-through facilities, automated teller machines, remote deposit capture and online and mobile banking applications. We offer by-appointment options for transactions requiring in-person contact while maintaining social distancing mandates and surface cleaning protocols. Our staff is practicing recommended personal hygiene protocols and social distancing while working on premises. We do not face current material resource constraints through the implementation of our pandemic preparedness plan and do not anticipate incurring any material cost related to its implementation. We have not identified any material operational or internal control challenges or risks, nor do we anticipate any significant challenges to our ability to maintain our systems and controls, related to operational changes resulting from implementation of the pandemic preparedness plan. Financial Position and Results of Operations Bank regulators have issued guidance and are encouraging banks to work with customers affected by COVID-19. Accordingly, we have been actively working with borrowers affected by COVID-19 by offering a payment deferral program providing for either a three-month interest-only period or a full payment deferral for three months. While interest and fees will continue to accrue to income, under normal GAAP accounting if eventual credit losses on these deferred payments emerge, interest and/or fee income accrued may need to be reversed. As a result, interest income in future periods could be negatively impacted. At this time management anticipates that the deferral program will have an immaterial impact to the Company’s financial condition and results of operation, while recognizing that a sustained negative economic impact from COVID-19 could change this assessment, as borrowers’ ability to repay is impacted in future periods. At September 30, 2022 the Company and the Banks were considered well-capitalized with capital ratios in excess of regulatory requirements. However, an extended economic recession resulting from the COVID-19 pandemic could adversely impact the Company’s and the Banks’ capital position and regulatory capital ratios due to a potential increase in credit losses. Lending Operations and Credit Risk As noted herein the Company continues working with its borrowers who are negatively impacted by COVID-19 by offering a payment deferral program. As of September 30, 2022, we had borrowers with 101 loans avail themselves of our payment deferral program with a total principal of $18.4 million in loans modified. A total of $815,000 in loans were accepted into the Company’s loan payment deferral plan. At June 30, 2022 all of those loans had reached the end of their three-month deferral periods and returned to regular payment status. 26 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Discussion of Financial Condition Changes from June 30, 2022 to September 30, 2022 (continued) The CARES Act and subsequent Consolidated Appropriations Act, 2021, includes a Paycheck Protection Program (“PPP”), which is administered by the Small Business Administration (“SBA”) and is designed to aid small- and medium-sized businesses through federally-guaranteed loans disbursed through banks. These loans are intended to provide eight weeks of payroll and other costs to assist those businesses to either remain open or to re-open quickly and allow their workers to pay their bills. First Federal of Kentucky qualified as an SBA lender to assist the small business community in securing this important funding. As of September 30, 2021, First Federal of Kentucky had approved and closed with the SBA 75 PPP loans representing $2.6 million in funding. Of those loans a total of 48 loans aggregating $2.0 million had been repaid at the end of the period. It is our understanding that loans funded through the PPP are fully guaranteed by the United States government. Should those circumstances change, the bank could be required to increase its allowance for loan and lease losses related to these loans resulting in an increase in the provision for loan and lease losses. The Banks are prepared to continue to offer short-term assistance in accordance with regulatory guidelines. Management continues to identify and monitor weaknesses in the loan portfolio resulting from fallout from the pandemic. On a portfolio level, management continues to monitor aggregate exposures to highly sensitive segments such as residential rental properties for changes in asset quality and payment performance. Management also monitors unfunded commitments such as lines of credit and overdraft protection to determine liquidity and funding issues that may arise with our customers. If economic conditions worsen, the Company could need to increase its required allowance for loan losses through additional provisions for loan losses. It is possible that the Company’s asset quality metrics could be materially and adversely impacted in future periods if the effects of COVID-19 are prolonged. Assets: At September 30, 2022, the Company’s assets totaled $330.9 million, an increase of $2.8 million, or 0.9%, from total assets at June 30, 2022. This increase was attributed primarily to an increase in loans, net, and investment securities, which were somewhat offset by a decrease in cash and cash equivalents. Cash and cash equivalents: Cash and cash equivalents decreased $17.2 million or 66.6% to $8.6 million at September 30, 2022. Most of the Company’s cash and cash equivalents are held in interest-bearing demand deposits. Investment securities: At September 30, 2022, our securities portfolio, which consisted of mortgage-backed securities, increased $3.7 million or 33.8% and totaled $14.5 million, compared to June 30, 2022. Loans : Loans, net and loans available-for sale in the aggregate increased $18.1 million or 6.6% and totaled $292.7 million and $0, respectively at September 30, 2022. Loans receivable, net, increased by $18.1 million or 6.6% to $292.7 million at September 30, 2022. Loans available-for-sale decreased $152,000 to $0 at September 30, 2022, as higher general interest rates have reduced demand for long-term, fixed rate loans in our market. Management continues to look for high-quality loans to add to its portfolio and will continue to emphasize loan originations to the extent that it is profitable, prudent and consistent with our interest rate risk strategies. Non-Performing and Classified Loans: At September 30, 2022, the Company had non-performing loans (loans 90 or more days past due or on nonaccrual status) of approximately $5.3 million, or 1.8% of total loans (including acquired loans), compared to $5.8 million or 2.1%, of total loans at June 30, 2022. The Company’s allowance for loan losses totaled $1.6 million and $1.5 million at September 30, 2022 and June 30, 2022, respectively. The allowance for loan losses at September 30, 2022, represented 31.1% of nonperforming loans and 0.6% of total loans (including acquired loans), while at June 30, 2022, the allowance represented 26.3% of nonperforming loans and 0.6% of total loans. The Company had $7.5 million in assets classified as substandard for regulatory purposes at September 30, 2022, including $7.5 million of loans acquired in the CKF Bancorp transaction, and real estate owned (“REO”) of $10,000. Classified loans as a percentage of total loans (including loans acquired) was 2.5% and 2.7% at September 30, 2022 and June 30, 2022, respectively. Of substandard loans, 100.0% were secured by real estate on which the Banks have priority lien position. The table below shows the aggregate amounts of our assets classified for regulatory purposes at the dates indicated: (dollars in thousands) September 30, 2022 June 30, 2022 Substandard assets $ 7,489 $ 7,458 Doubtful assets – – Loss assets – – Total classified assets $ 7,489 $ 7,458 At September 30, 2022, the Company’s real estate acquired through foreclosure represented 0.1% of substandard assets compared to 0.1% at June 30, 2022. During the period presented the Company made no loans to facilitate the purchase of its other real estate owned by qualified buyers. Loans to facilitate the sale of other real estate owned, which were included in substandard loans, totaled $0 and $0 at September 30, 2022 and June 30, 2022, respectively. 27 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Discussion of Financial Condition Changes from June 30, 2022 to September 30, 2022 (continued) The following table presents the aggregate carrying value of REO at the dates indicated: September 30, 2022 June 30, 2022 Number of Properties Net Carrying Value Number of Properties Net Carrying Value One- to four-family 1 $ 10 1 $ 10 Building lot – – – – Total REO 1 $ 10 1 $ 10 At September 30, 2022 and June 30, 2022, the Company had $887,000 and $896,000 of loans classified as special mention, respectively (including loans acquired in the CKF Bancorp transaction on December 31, 2012). This category includes assets which do not currently expose us to a sufficient degree of risk to warrant classification, but does possess credit deficiencies or potential weaknesses deserving our close attention. Liabilities: Total liabilities increased $3.2 million, or 1.2% to $279.3 million at September 30, 2022, primarily as a result of increases in advances and was somewhat offset by a decrease in deposits. Advances increased $16.7 million or 50.0% to $50.8 million at September 30, 2022, while deposits decreased $13.6 million or 5.7% to $226.3 million at September 30, 2022. Of the deposit decrease certificates of deposit decreased $7.6 million or 6.1% and totaled $117.1 million at September 30, 2022, while demand deposit accounts decreased $5.1 million or 12.8% and totaled $34.6 million at quarter end. Savings accounts decreased $931,000 or 1.2% and totaled $74.6 million at the end of the current period. We attribute the decrease in overall deposits to customers seeking to earn additional yield on their funds and plan to respond with deposit pricing intended to retain the Banks’ overall core funding. Shareholders’ Equity: At September 30, 2022, the Company’s shareholders’ equity totaled $51.6 million, a decrease of $396,000 or 0.8% from the June 30, 2022 total. The decrease in shareholders’ equity was primarily associated with unrealized losses on available-for-sale securities, which totaled $430,000 at September 30, 2022. Other changes in shareholders’ equity included net profits for the period less dividends paid on common stock. The Company paid dividends of $342,000 or 91.7% of net income for the three-month period just ended. On July 7, 2022, the members of First Federal MHC again approved a dividend waiver on annual dividends of up to $0.40 per share of Kentucky First Federal Bancorp common stock. The Board of Directors of First Federal MHC applied for approval of another waiver. The Federal Reserve Bank of Cleveland has notified the Company that it did not object to the waiver of dividends paid by the Company to First Federal MHC, and, as a result, First Federal MHC will be permitted to waive the receipt of dividends for quarterly dividends up to $0.10 per common share through the third calendar quarter of 2023. Management believes that the Company has sufficient capital to continue the current dividend policy without affecting the well-capitalized status of either subsidiary bank. Management cannot speculate on future dividend levels, because various factors, including capital levels, income levels, liquidity levels, regulatory requirements and overall financial condition of the Company are considered before dividends are declared. However, management continues to believe that a strong dividend is consistent with the Company’s long-term capital management strategy. See “Risk Factors” in Part II, Item 1A, of the Company’s Annual Report on Form 10-K for the year ended June 30, 2022 for additional discussion regarding dividends. 28 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Comparison of Operating Results for the Three-month Periods Ended September 30, 2022 and 2021 General Net income totaled $373,000 or $0.05 diluted earnings per share for the three months ended September 30, 2022, a decrease of $195,000 or 34.3% from net income of $568,000 or $0.07 diluted earnings per share for the same period in 2021. The decrease in net income was primarily attributable to lower non-interest income, higher provision for loan loss, and lower net interest income, which were partially offset by lower non-interest expense, and lower income tax. Net Interest Income Net interest income decreased $73,000 or 2.9% to $2.4 million for the recently-ended quarter primarily due to decreased interest income, which decreased $89,000 or 3.0% to $2.9 million for the three months ended September 30, 2022 compared to the 2021 quarterly period, while interest expense decreased by $16,000, or 3.4%, to $453,000 for the current period. The decrease in interest income was due primarily to a decrease in interest income from loans, which decreased $290,000 or 9.9% to $2.6 million compared to the prior year period. Interest income from mortgage-backed securities and interest-bearing deposits and other increased $111,000 and $90,000, respectively from the 2021 quarterly period to the one just ended. Interest income from mortgage-backed securities totaled $114,000 for the quarter ended September 30, 2022, due to an increase in investments made recently in that asset class, while interest income from interest-bearing deposits and other totaled $127,000 for the period and is due primarily to higher interest rates earned on those assets. The decrease in interest income from loans period-to-period was due to decreases in both the average balance of loans and the average rate earned on those loans. The average balance of loans decreased $14.6 million or 4.9% to $283.6 million for the three months ended September 30, 2022, while the average rate decreased 21 basis points to 3.73% for the recently-ended three-month period compared to the prior year period. The decrease in the average balance of loans in the portfolio was due to several reasons. Prior to the interest rate tightening which began in March 2022 interest rates in general remained quite low. The low interest rate environment, along with strong consumer demand that occurred after COVID-19 pandemic restrictions eased, fueled strong demand in the real estate market. Some of the Banks’ borrowers decided to take advantage of high property prices and sold all or part of their real estate holdings, while other borrowers sold their properties due to advanced age or death. Other loans were lost to competing financial institutions who offered terms that we did not believe were prudent to match. However, in the past six months the Banks have been able to partially build back the loan portfolio. The average return on loans indicates a downward trend reflective of overall lower loan balances and stagnant rates in the recent past. Prior to June 30, 2022, most loans that were paid off were either replaced with loans with lower rates or were refinances to lower rates. Loans with adjustable rate features were either adjusting downward or not adjusting at all. In the quarter ended September 30, 2022, loan originations increased significantly, newer loans had higher rates, and some loans with adjustable rate features had increases in rates. The effect of this was not clearly shown in the interest earned during the quarter and may be better reflected by stating that the weighted-average coupon rate on loans at September 30, 2022 had increased 27 bps to 3.74% from 3.47% at September 30, 2021. The decrease in interest expense was due primarily to a decrease in interest expense on deposits, which decreased $18,000 or 4.9% and totaled $350,000 for the quarter ended September 30, 2022. The composition of interest expense on deposits changed period to period as interest expense on savings accounts increased $34,000 or 50.0% and totaled $102,000, while interest expense on certificates of deposit decreased $54,000 or 18.6% and totaled $237,000 for the three months ended September 30, 2022. We believe that the change was related to the interest rate increases that began in March 2022 and consumers’ response to higher interest rates compared to a relatively long period of low interest rates. The average rate paid on savings accounts increased 15 basis points to 0.54%, while the average rate paid on certificates of deposit decreased 14 basis points to 0.78% for the three months ended September 30, 2022. The average balance of borrowings decreased $15.6 million from period to period, while the average rate paid on borrowings increased 33 basis points to 1.08% for the recently-ended quarter. We expect interest expense to increase in the future as we use FHLB advances to replace deposits that are leaving the Banks in search of higher yield. FHLB advance rates have increased along with the rise in general interest rates. In addition, the Banks will be implementing deposit pricing strategies intended to retain core deposit funding, which is expected to result in higher interest expense. Net interest spread increased from 2.94% for the prior year quarterly period to 2.96% for the three-month period ended September 30, 2022. Provision for Losses on Loans Management determined that a $113,000 provision for loan loss was prudent in light of the relatively large increase in the loan portfolio during the recently-ended quarter. Loans, net, increased $18.1 million or 6.6% and totaled $292.7 million at September 30, 2022, compared to $274.6 million at June 30, 2022. The additional provision was appropriate not only for the increase in the loan portfolio but also, in part, to reflect an increase in multi-family loans, which increased $9.0 million or 63.2% and totaled $23.3 million at September 30, 2022. Multi-family loans carry a slightly higher risk profile than 1-4 family residential loans, which makes up the greatest portion of the Company’s loan portfolio. 29 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Comparison of Operating Results for the Three-month Periods Ended September 30, 2022 and 2021 (continued) Non-interest Income Non-interest income decreased $130,000 or 57.0% to $98,000 for the three months ended September 30, 2022, compared to the prior year period, primarily because of a decrease in net gains on sales of loans. Net gain on sales of loans decreased $155,000 or 95.7% to $7,000 for the recently-ended three-month period. Interest rates have risen significantly since March 2022, which has resulted in a reduced number of customers interested in long-term fixed rate loans which the Company routinely sells to the FHLB of Cincinnati after they are originated. Non-interest Expense Non-interest expense decreased $53,000 or 2.7% and totaled $1.9 million for the three months ended September 30, 2022, primarily due to decreased employee compensation and benefits and was somewhat offset by increased outside service fees as well as increased accounting and auditing expense. Employee compensation and benefits expense decreased $148,000 or 11.0% and totaled $1.2 million for the quarterly period just ended, as pension-related costs decreased year over year. Required contributions to the Company’s defined benefit pension plan (DB plan) decreased by $135,000 due to favorable funding levels, while ESOP expense decreased by $35,000 as the employee stock ownership plan is scheduled to release fewer shares this calendar year. Auditing and accounting expense increased $27,000 or 50.0% and totaled $81,000 as the Banks incurred additional outside costs associated with internal controls testing. Although some of the work had been performed in-house previously, time constraints made outsourcing necessary at the time. Income Tax Expense Income tax expense decreased $68,000 or 37.0% to $116,000 for the three months ended September 30, 2022, compared to the prior year period. The effective tax rates for the three-month periods ended September 30, 2022 and 2021, were 23.7% and 24.5%, respectively. 30 Kentucky First Federal Bancorp ITEM 3: Quantitative and Qualitative Disclosures About Market Risk This item is not applicable as the Company is a smaller reporting company.