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, as well as other periodic reports filed with the Securities and Exchange Commission, that are not historical facts are considered “forward-looking statements” under the Private Securities Litigation Reform Act of 1995, that are subject to certain risks and uncertainties. These forward-looking statements may be identified by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “intend” and “potential,” or words of similar meaning, or future or conditional verbs such as “should,” “could,” or “may.” Forward-looking statements include statements of our goals, intentions and expectations; statements regarding our business plans, prospects, growth and operating strategies; statements regarding the quality of our loan and investment portfolios; and estimates of our risks and future costs and benefits. 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 the level of inflation; changes in the demand for loans, deposits and other financial services that we provide; the possibility that future credit losses may be higher than currently expected; the impact of the interest rate environment on our business, financial condition and results of operations; competitive pressures among financial services companies; the ability to attract, develop and retain qualified employees; the ability to pay future dividends at currently expected rates; our ability to maintain the security of our data processing and information technology systems; the outcome of pending or threatened litigation, or of matters before regulatory agencies; 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. Asset/Liability Management Management and the boards of the subsidiary Banks are responsible for the asset/liability management issues that affect the individual Banks. Either Bank may work with its sister Bank to mitigate potential asset/liability risks to the Banks and to the Company as a whole. Management utilizes a third-party to perform interest rate risk (“IRR”) calculations for each of the Banks. Management monitors and considers methods of managing the rate sensitivity and repricing characteristics of each of the Bank’s balance sheet components to maintain acceptable levels of change in the economic value of equity (“EVE”) as well as evaluating the impact on earnings in the event of changes in prevailing market interest rates. Interest rate sensitivity analysis is used to measure our interest rate risk by computing estimated changes in EVE that are a result of changes in the net present value of its cash flows from assets, liabilities, and off-balance sheet items. These changes in cash flow are estimated based on hypothetical instantaneous and permanent increases and decreases in market interest rates. In March 2022 the Federal Open Market Committee (“FOMC”) of the Federal Reserve Bank began raising the target range for the fed funds rate of interest and since that time has raised the short-term interest rate by 500 basis points. At March 31, 2023, we believe our risk associated with rising interest rates was moderate. Our IRR model indicated that at March 31, 2023, our EVE was approximately 16.5%, despite the historic interest rate increases during the previous twelve months. Although general market participants believe that the FOMC will now pause interest rate increases for a period of time, our March 31, 2023 EVE is anticipated to be approximately 14.7% and 11.7% under sudden and sustained increase in prevailing market interest rates of 100 basis points and 200 basis points, respectively. Computations or prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments, and deposit run-offs. These computations should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Banks may undertake in response to changes in interest rates. Certain shortcomings are inherent in this method of computing EVE. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in differing degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. 28 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 nine-month periods ended March 31, 2023 and 2022, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods. Nine Months Ended March 31, 2023 2022 Average Balance Interest And Dividends Yield/ Cost Average Balance Interest And Dividends Yield/ Cost (Dollars in thousands) Interest-earning assets: Loans 1 $ 294,651 $ 8,522 3.86 % $ 287,377 $ 8,190 3.80 % Mortgage-backed securities 13,787 345 3.34 445 8 2.40 Other interest-earning assets 13,241 359 3.61 40,067 118 0.39 Total interest-earning assets 321,679 9,226 3.82 327,889 8,316 3.38 Less: Allowance for loan losses (1,611 ) (1,607 ) Non-interest-earning assets 12,026 12,124 Total assets $ 332,094 $ 338,406 Interest-bearing liabilities: Demand deposits $ 20,415 $ 29 0.19 % $ 19,398 $ 29 0.20 % Savings 70,844 235 0.44 72,729 203 0.37 Certificates of deposit 115,822 844 0.97 126,614 823 0.87 Total interest-bearing deposits 207,081 1,108 0.71 218,741 1,055 0.64 Borrowings 58,348 1,193 2.73 49,934 285 0.76 Total interest-bearing liabilities 265,429 2,301 1.16 268,675 1,340 0.67 Noninterest-bearing demand deposits 13,588 15,155 Noninterest-bearing liabilities 1,467 2,246 Total liabilities 280,484 286,076 Shareholders’ equity 51,610 52,330 Total liabilities and shareholders’ equity $ 332,094 $ 338,406 Net interest spread $ 6,925 2.66 % $ 6,976 2.71 % Net interest margin 2.87 % 2.84 % Average interest-earning assets to average interest-bearing liabilities 120.19 % 122.04 % 1 Includes loan fees, immaterial in amount, in both interest income and the calculation of yield on loans. Also includes loans on nonaccrual status. 29 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 March 31, 2023 and 2022, 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 March 31, 2023 2022 Average Balance Interest And Dividends Yield/ Cost Average Balance Interest And Dividends Yield/ Cost (Dollars in thousands) Interest-earning assets: Loans 1 $ 304,014 $ 2,983 3.93 % $ 274,197 $ 2,513 3.67 % Mortgage-backed securities 13,498 116 3.44 405 2 2.96 Other interest-earning assets 9,562 111 4.64 51,544 46 0.35 Total interest-earning assets 327,074 3,210 3.93 326,146 2,561 3.14 Less: Allowance for loan losses (1,665 ) (1,599 ) Non-interest-earning assets 12,309 12,094 Total assets $ 337,718 $ 336,641 Interest-bearing liabilities: Demand deposits $ 19,370 $ 9 0.19 % $ 19,398 $ 10 0.21 % Savings 63,810 62 0.39 75,004 68 0.36 Certificates of deposit 112,683 383 1.36 126,964 258 0.81 Total interest-bearing deposits 195,863 454 0.93 221,366 336 0.61 Borrowings 76,888 711 3.70 45,302 87 0.77 Total interest-bearing liabilities 272,751 1,165 1.71 266,668 423 0.63 Noninterest-bearing demand deposits 12,418 15,155 Noninterest-bearing liabilities 1,109 2,282 Total liabilities 286,279 284,105 Shareholders’ equity 51,440 52,536 Total liabilities and shareholders’ equity $ 337,719 $ 336,641 Net interest spread $ 2,045 2.22 % $ 2,138 2.51 % Net interest margin 2.50 % 2.62 % Average interest-earning assets to average interest-bearing liabilities 119.92 % 122.30 % 1 Includes loan fees, immaterial in amount, in both interest income and the calculation of yield on loans. Also includes loans on nonaccrual status. 30 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 March 31, 2023 Financial Position and Results of Operations At March 31, 2023 the Company and the Banks were considered well-capitalized with capital ratios in excess of regulatory requirements. However, an extended economic recession could adversely impact the Company’s and the Banks’ capital position and regulatory capital ratios due to a potential increase in credit losses. Assets: At March 31, 2023, the Company’s assets totaled $342.9 million, an increase of $14.8 million, or 4.5%, from total assets at June 30, 2022. This increase was attributed primarily to increases in loans, net. Cash and cash equivalents: Cash and cash equivalents decreased $17.7 million or 68.7% to $8.1 million at March 31, 2023. Most of the Company’s cash and cash equivalents are held in interest-bearing demand deposits. Investment securities: At March 31, 2023, our securities portfolio, which consisted of mortgage-backed securities, increased $2.3 million or 21.6% and totaled $13.2 million, compared to June 30, 2022. Loans : Loans, net increased $32.4 million or 11.8% and totaled $307.0 million at March 31, 2023. Residential real estate loans comprise 86.2% of our loan portfolio at March 31, 2023, and approximately 86.6% of those loans have adjustable rates, although newly-originated loans have a period of time during which no rate adjustments can occur. After the initial period the applicable interest rates can change annually within limits and all such loans have ceiling rates. One- to four-family, multi-family and construction loans increased $20.4 million, $5.6 million and $7.9 million from June 30, 2022, respectively. Equity lines of credit, which have interest rates that can change monthly with the prime rate of interest, totaled $8.7 million at March 31, 2023. 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 March 31, 2023, the Company had non-performing loans (loans 90 or more days past due or on nonaccrual status) of approximately $5.9 million, or 1.9% 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 March 31, 2023 and June 30, 2022, respectively. The allowance for loan losses at March 31, 2023, represented 27.8% of nonperforming loans and 0.5% 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 $7.6 million in assets classified as substandard for regulatory purposes at March 31, 2023, and real estate owned (“REO”) of $70,000. Classified loans as a percentage of total loans (including loans acquired) was 2.5% and 2.7% at March 31, 2023 and June 30, 2022, respectively. Of substandard loans, 99.0% 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) March 31, 2023 June 30, 2022 Substandard assets $ 7,629 $ 7,458 Doubtful assets – – Loss assets – – Total classified assets $ 7,629 $ 7,458 At March 31, 2023, the Company’s real estate acquired through foreclosure represented 0.9% 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 March 31, 2023 and June 30, 2022, respectively. 31 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Comparison of Operating Results for the Nine-month Periods Ended March 31, 2023 and 2022 General Net income totaled $891,000 or $0.11 diluted earnings per share for the nine months ended March 31, 2023, a decrease of $493,000 or 35.6% from net income of $1.4 million or $0.17 diluted earnings per share for the same period in 2022. The decrease in net income on a nine-month basis was primarily attributable to increased provision for loan losses, lower non-interest income, higher non-interest expense, and decreased net interest income. Net Interest Income Net interest income before provision for loan losses decreased $51,000 or 0.7% to $6.9 million for the nine-month period just ended, as interest expense increased by $961,000, or 71.7%, to $2.3 million, while interest income increased $910,000 or 10.9% to $9.2 million for the nine months ended March 31, 2023. The increase in interest expense period-to-period was due primarily to a 49 basis points increase in the average rate paid on interest-bearing liabilities, which increased to 1.16% for the recently-ended nine-month period compared to the prior year period despite a decrease in the average balance of interest-bearing liabilities by $3.2 million or 1.2% to $265.4 million for the nine months ended March 31, 2023. Deposits and FHLB advances are the primary funding sources utilized by the Company and interest expense on those funds increased in response to the 500 basis point increase in the discount rate implemented by the Federal Open Market Committee of the Federal Reserve Bank (“FOMC”) beginning March 2022. Although the yield on the Company’s assets generally changes in response to interest rate changes, those assets do not reprice as quickly as funding sources reprice. As such, interest expense on borrowings increased $908,000 or 318.6% to $1.2 million for the nine months just ended, while interest expense on deposits increased $53,000 or 5.0% to $1.1 million. Deposit balances decreased in the first two quarters of the fiscal year as general interest rates in the market rose and customers sought higher yields on their interest-bearing funds. Many financial institutions experienced an outflow of deposit balances in 2022 after balance sheets swelled during the COVID-19 pandemic due to government stimulus funding and limited spending opportunities for customers. Our deposit balances decreased approximately $13.6 million and $17.0 million for the quarterly periods ended September 30, and December 31, 2022, respectively, but increased approximately $8,000 for the recently-ended quarter. Unlike some financial institutions which have struggled with high levels of uninsured bank deposits on their books, our Banks maintain a relatively low 13% of deposits which are not insured by the Federal Deposit Insurance Corporation (“FDIC”). If the FOMC continues to increase, management expects net earnings to be negatively impacted as the cost of funding is expected to increase faster than the yield on assets increases. The extent of any such negative impact will be largely dependent on whether and how much the FOMC continues to escalate interest rates. The fed funds futures market at this time indicates a general belief that the FOMC is finished increasing rates for the time being, which is anticipated to benefit our Company by allowing assets to continue repricing while the repricing of deposits slows. Interest income increased year over year for all components of interest-earning assets due primarily to reallocation of the assets and an increase in the average rate earned on those assets, which increased 44 basis points to 3.82%. Although the average balance decreased $6.2 million or 1.9% to $321.7 million for the nine-month period ended March 31, 2023, we were able to redirect $26.8 million or 67.0% of our other interest-earning assets into loans and investments, which were able to earn higher yields. Interest income from loans increased $332,000 or 4.1% to $8.5 million, due chiefly to a $7.3 million or 2.5% increase in average balances, which totaled $294.7 million for the recently-ended period, while the average yield earned increased six basis points to 3.86%. Interest income from mortgage-backed securities increased $337,000 to $345,000 primarily due to an increase in average balance maintained during the period, which totaled $13.8 million for the current year period compared to $445,000 in the prior year and a 94 basis points increase in the average rate earned, which totaled 3.34% for the nine months just ended. Interest income on interest-bearing deposits and other increased $241,000 and totaled $359,000 for the nine months just ended due to an increase in the average rate earned on those assets, which totaled 3.61% for the nine months ended March 31, 2023, compared to 39 basis points for the prior year period. Net interest spread decreased from 2.71% for the prior year period to 2.66% for the nine-month period ended March 31, 2023. Provision for Losses on Loans Management determined that a $113,000 provision for loan loss was appropriate in light of the relatively large increase in the loan portfolio during the period. Loans, net, increased $32.4 million or 11.8% and totaled $307.0 million at March 31, 2023, 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 $5.6 million or 39.3% and totaled $19.9 million at March 31, 2023. 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. 32 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Comparison of Operating Results for the Nine-month Periods Ended March 31, 2023 and 2022 (continued) Non-interest Income Non-interest income decreased $186,000 or 44.1% to $236,000 for the nine months ended March 31, 2023, compared to the prior year period, primarily due to decreased net gains on sales of loans. Net gain on sales of loans decreased $225,000 to $6,000 for the recently-ended nine-month period. Interest rates in the general market have risen significantly since March 2022, which has resulted in a reduced demand for long-term fixed rate loans. The Company routinely sells long-term, fixed rate loans to the FHLB of Cincinnati after they are originated. Non-interest Expense Non-interest expense increased $128,000 or 2.2% to $5.9 million for the nine months ended March 31, 2023, primarily due to higher auditing and accounting costs and outside service fees. Auditing and accounting costs increased $84,000 or 65.6% to $212,000 for the recently-ended period due to increased internal and external audit expenses. Outside service fees increased $48,000 or 36.1% to $181,000 for the nine months just ended as we incurred additional costs across our banking business including loan review, computer technology services, and interest rate monitoring, as well as general business expenses associated with public company operation and operation of employee benefits. Other non-interest expense increased $40,000 or 9.3% to $468,000 for the nine months ended March 31, 2023 due primarily to costs associated with various administrative expenses including employee training, bank logistics and contributions to aid those who suffered historic flash flooding in our easternmost bank service area. Income Tax Expense Income tax expense decreased $91,000 or 24.3% to $283,000 for the nine months ended March 31, 2023, compared to the prior year period. The effective tax rates for the nine-month periods ended March 31, 2023 and 2022, were 24.1% and 21.3%, respectively. 33 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 March 31, 2023 and 2022 General Net income totaled $144,000 or $0.02 diluted earnings per share for the three months ended March 31, 2023, a decrease of $190,000 or 56.9% from net income of $334,000 or $0.04 diluted earnings per share for the same period in 2022. The decrease in net earnings for the quarter ended was primarily attributable to provision for losses on loans and lower net interest income. Net Interest Income Net interest income before provision for losses on loans decreased $93,000 or 4.4% to $2.0 million for the three-month period just ended, as interest expense increased at a faster pace than interest income. Interest expense increased by $742,000, or 175.4%, to $1.2 million, while interest income increased $649,000 or 25.3% to $3.2 million for the three months ended March 31, 2023. The increase in interest income period-to-period was led by an increase in interest income on loans and was strongly supported by increases in interest income on mortgage-backed securities. Interest income on loans increased $470,000 or 18.7% to $3.0 million for the quarterly period just ended due to both increased average balance of loans in the portfolio and increased average rate earned. The average balance of loans, net increased $29.8 million or 10.9% to $304.0 million for the period, while the average balance earned on those assets increased 26 basis points to 3.93%. Interest income on mortgage-backed securities increased $114,000 to $116,000 for the three months ended March 31, 2023, and was due primarily to an increase in the average balance, which increased $13.1 million to $13.5 million for the quarter just ended, while the average rate increased 48 basis points to 3.44% for the period. Interest income on interest-bearing deposits and other increased $65,000 and totaled $111,000 for the quarter just ended due to a 4.29% increase in the average rate earned on those assets, which totaled 4.64% for the period. The average balance of other interest-earning assets decreased $42.0 million or 81.4% to $9.6 million for the recently-ended quarter, as we redeployed assets primarily into loans. The increase in interest expense was attributed primarily to an increase in interest expense on borrowings, which increased $624,000 to $711,000 for the recently-ended quarterly period, while interest expense on deposits increased $118,000 or 35.1% to $454,000. Interest expense on borrowings increased chiefly due to an increase in the average rate paid on those funds, which increased 293 basis points to 3.70% for the three months just ended, while the average balance increased $31.6 million or 67.7% to $76.9 million. Advances were used to replace deposits, whose average balance decreased $25.5 million or 11.5% to $195.9 million for the three months just ended due to deposit decreases occurring in the first two quarters of this fiscal year, as described above. The average rate paid on interest-bearing deposits increased 32 basis points to 0.93% for the recently ended period. Net interest spread decreased 29 basis points from 2.51% for the prior year quarterly period to 2.22% for the three-month period ended March 31, 2023. Provision for Losses on Loans The Company recorded no provision for loan losses for the three-month period ended March 31, 2023, while a negative provision of $106,000 was made for the three-month period ended March 31, 2022. 34 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 March 31, 2023 and 2022 (continued) Non-interest Income Non-interest income decreased $25,000 or 26.6% to $69,000 for the recently ended quarter due primarily to decreased net gains on sales of loans. Interest rates have risen significantly since March 2022, which has resulted in a reduced demand for 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 increased $45,000 or 2.4% to $1.9 million for the quarter ended March 31, 2023, due primarily to higher outside service fees. Outside service fees increased $46,000 or 148.4% to $77,000 for the three months just ended as we incurred additional costs across our banking business including loan review, computer technology services, and interest rate monitoring, as well as general business expenses associated with public company operation and operation of employee benefits. Management expects these higher costs to continue at the higher levels and, although in some cases these costs are related to expanded services, the primary cause of the higher costs was general inflation. Income Tax Expense Income tax expense decreased $79,000 or 59.4% to $54,000 for the three months ended March 31, 2023, compared to the prior year period. The effective tax rates for the three-month periods ended March 31, 2023 and 2022 were 27.3% and 28.5%, respectively. 35 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.