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; the interest rate environment and the impact of the interest rate environment on our business, financial condition and results of operations; our ability to successfully execute our strategy to increase earnings, increase core deposits, reduce reliance on higher cost funding sources and shift more of our loan portfolio towards higher-earning loans; our ability to pay future dividends and if so at what level; our ability to receive any required regulatory approval or non-objection for the payment of dividends from First Federal Savings and Loan Association of Hazard and First Federal Savings Bank of Kentucky to the Company or from the Company to shareholders; 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; competitive pressures among financial services companies; the ability to attract, develop and retain qualified employees; 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, and the other matters mentioned in Item 1A of the Company’s Annual Report on Form 10-K for the year ended June 30, 2023 and in the Company’s Quarterly Report on Form 10-Q for the period ended December 31, 2023 and for the period ended September 30, 2023. 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, 2024, we believe our risk associated with rising interest rates was moderate. Our IRR model indicated that at December 31, 2023, our EVE was approximately 16.4%, 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 December 31, 2023 EVE is anticipated to be approximately 14.7% and 10.6% 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. 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 nine-month periods ended March 31, 2024 and 2023, 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, 2024 2023 Average Balance Interest And Dividends Yield/ Cost Average Balance Interest And Dividends Yield/ Cost (Dollars in thousands) Interest-earning assets: Loans 1 $ 323,370 $ 10,927 4.51 % $ 294,651 $ 8,522 3.86 % Mortgage-backed securities 11,300 288 3.40 13,787 345 3.34 Other interest-earning assets 14,817 619 5.57 13,241 359 3.61 Total interest-earning assets 349,487 11,834 4.51 321,679 9,226 3.82 Less: Allowance for credit losses (1,925 ) (1,611 ) Non-interest-earning assets 12,452 12,026 Total assets $ 360,014 $ 332,094 Interest-bearing liabilities: Demand deposits $ 17,159 $ 23 0.18 % $ 20,415 $ 29 0.19 % Savings 54,154 165 0.41 70,844 235 0.44 Certificates of deposit 156,984 4,122 3.50 115,822 844 0.97 Total interest-bearing deposits 228,297 4,310 2.52 207,081 1,108 0.71 Borrowings 65,645 2,432 4.94 58,348 1,193 2.73 Total interest-bearing liabilities 293,942 6,742 3.06 265,429 2,301 1.16 Noninterest-bearing demand deposits 14,738 13,588 Noninterest-bearing liabilities 1,732 1,467 Total liabilities 310,412 280,484 Shareholders’ equity 49,602 51,610 Total liabilities and shareholders’ equity $ 360,014 $ 332,094 Net interest spread $ 5,092 1.46 % $ 6,925 2.66 % Net interest margin 1.94 % 2.87 % Average interest-earning assets to average interest-bearing liabilities 118.90 % 120.19 % 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) Average Balance Sheets The following table represents the average balance sheets for the three-month periods ended March 31, 2024 and 2023, 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, 2024 2023 Average Balance Interest And Dividends Yield/ Cost Average Balance Interest And Dividends Yield/ Cost (Dollars in thousands) Interest-earning assets: Loans 1 $ 328,385 $ 3,841 4.68 % $ 304,014 $ 2,983 3.93 % Mortgage-backed securities 10,787 97 3.60 13,498 116 3.44 Other interest-earning assets 17,936 235 5.24 9,562 111 4.64 Total interest-earning assets 357,108 4,173 4.67 327,074 3,210 3.93 Less: Allowance for credit losses (2,130 ) (1,665 ) Non-interest-earning assets 12,611 12,309 Total assets $ 367,589 $ 337,718 Interest-bearing liabilities: Demand deposits $ 16,197 $ 7 0.17 % $ 19,370 $ 9 0.19 % Savings 51,366 53 0.41 63,810 62 0.39 Certificates of deposit 161,144 1,526 3.79 112,683 383 1.36 Total interest-bearing deposits 228,707 1,586 2.77 195,863 454 0.93 Borrowings 72,821 822 4.52 76,888 711 3.70 Total interest-bearing liabilities 301,528 2,408 3.19 272,751 1,165 1.71 Noninterest-bearing demand deposits 15,659 12,418 Noninterest-bearing liabilities 1,365 1,109 Total liabilities 318,552 286,278 Shareholders’ equity 49,037 51,440 Total liabilities and shareholders’ equity $ 367,589 $ 337,718 Net interest spread $ 1,765 1.48 % $ 2,045 2.22 % Net interest margin 1.98 % 2.50 % Average interest-earning assets to average interest-bearing liabilities 118.43 % 119.92 % 1 Includes loan fees, immaterial in amount, in both interest income and the calculation of yield on loans. Also includes loans on nonaccrual status. 31 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, 2023 to March 31, 2024 Financial Position and Results of Operations At March 31, 2024 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, 2024, the Company’s assets totaled $369.1 million, an increase of $20.1 million, or 5.8%, from total assets at June 30, 2023. This increase was attributed primarily to increases in loans, net, primarily in adjustable rate residential mortgage loans Cash and cash equivalents: Cash and cash equivalents increased $7.2 million or 88.8% to $15.4 million at March 31, 2024. Most of the Company’s cash and cash equivalents are held in interest-bearing demand deposits. Investment securities: At March 31, 2024, our securities portfolio, which consisted of mortgage-backed securities, decreased $1.9 million or 15.4% and totaled $10.4 million, compared to June 30, 2023. Loans : Loans, net increased $14.3 million or 4.6% and totaled $328.1 million at March 31, 2024. 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, 2024, the Company had non-performing loans (loans 90 or more days past due or on nonaccrual status) of approximately $5.2 million, or 1.6% of total loans (including acquired loans), compared to $5.4 million or 1.7%, of total loans at June 30, 2023. The Company’s ACL totaled $2.1 million at March 31, 2024 and the Company’s allowance for loan loss totaled $1.6 million at June 30, 2023. The ACL at March 31, 2024, represented 40.4% of nonperforming loans and 0.6% of total loans, while at June 30, 2023, ALLL represented 34.8% of nonperforming loans and 0.5% of total loans. The Company had $7.6 million in assets classified as substandard for regulatory purposes at March 31, 2024, and real estate owned (“REO”) of $10,000. Classified loans as a percentage of total loans (including loans acquired) was 2.4% and 2.3% at March 31, 2024 and June 30, 2023, 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) March 31, 2024 June 30, 2023 Substandard assets $ 7,594 $ 7,266 Doubtful assets – – Loss assets – – Total classified assets $ 7,594 $ 7,266 At March 31, 2024, the Company’s real estate acquired through foreclosure represented 0.1% of substandard assets compared to 0.1% at June 30, 2023. 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, 2024 and June 30, 2023, respectively. 32 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, 2023 to March 31, 2024 (continued) The following table presents the aggregate carrying value of REO at the dates indicated: March 31, 2024 June 30, 2023 Number of Properties Net Carrying Value Number of Properties Net Carrying Value One- to four-family 1 $ 10 2 $ 70 Total REO 1 $ 10 2 $ 70 At March 31, 2024 and June 30, 2023, the Company had $810,000 and $854,000 of loans classified as special mention, respectively. 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 $21.8 million, or 7.3% to $320.1 million at March 31, 2024, as deposits increased $19.8 million or 8.7% to $246.1 million and advances increased $2.3 million or 3.2% to $72.3 million. Certificates of deposit increased $26.7 million or 19.4% and totaled $164.0 million at March 31, 2024, which included $43.9 million of brokered deposits, an increase of $22.9 million or 108.8%. Demand deposit accounts increased $1.6 million or 5.1% and totaled $33.0 million at quarter end. Savings accounts decreased $8.5 million or 14.7% and totaled $49.1 million at the end of the current period. The cost of liabilities has been increasing rapidly due to higher costs of both wholesale and retail funding. Continued increases in liability costs, especially for wholesale funds, will primarily be driven by future increases in market rates by the Federal Reserve. It is believed that we are near the peak of this rate cycle which, if so, will likely slow the increasing costs of our liabilities. Shareholders’ Equity: At March 31, 2024, the Company’s shareholders’ equity totaled $49.0 million, a decrease of $1.7 million or 3.3% from the June 30, 2023 total. The decrease in shareholders’ equity was primarily associated with adoption of the CECL accounting standard which resulted in a $414,000 net loss for the period and dividends paid on common stock. The Company paid dividends of $671,000 and had net loss of $643,000 for the nine-month period just ended. On July 6, 2023, 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 was permitted to waive the receipt of dividends for quarterly dividends up to $0.10 per common share through the third calendar quarter of 2024. However, on October 13, 2023, the Company announced that future dividends will be reduced primarily due to the recent decline in earnings of the Banks. After careful consideration, on January 16, 2024, the board determined that it would be prudent to suspend the payment of dividends completely until such time as earnings and liquidity improve. Our ability to pay future dividends and if so at what level will also be dependent on our ability to successfully execute our strategy to increase earnings and core deposits, reduce reliance on higher cost funding sources and shift more of our loan portfolio towards higher-earning loans, and the receipt of required regulatory approval or non-objection for the payment of dividends from the Banks to the Company or from the Company to shareholders. Nevertheless, 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, 2023 for additional discussion regarding dividends. 33 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, 2024 and 2023 General Net income totaled $(643,000) or $(0.08) diluted earnings per share for the nine-months ended March 31, 2024, a decrease of $1.5 million or 172.2% from net income of $891,000 or $0.11 diluted earnings per share for the same period in 2023. The decrease in net earnings for the nine months ended March 31, 2024 was primarily attributable to lower net interest income, and higher non-interest expense, which were partially offset by lower income taxes and lower provision for credit losses. Net Interest Income Net interest income decreased $1.8 million or 26.5% to $5.1 million due primarily to interest expense increasing more than interest income increased period to period. Interest expense increased $4.4 million or 193.0%, while interest income increased $2.6 million or 28.3% to $11.8 million for the nine months ended March 31, 2024. During the unprecedented interest rate increases experienced in the market since March 2022, our funding sources have repriced more quickly than our assets have repriced, which has had a negative impact on net interest income. The average rate earned on interest-earning assets increased 69 basis points to 4.52% and was the primary reason for the increase in interest income. The increase in interest income was due primarily to an increase of $2.4 million or 28.2% in interest income from loans, which totaled $10.9 million for the period. The increase in interest income from loans period-to-period was due to increases in both the average balance of loans and the average rate earned on those loans. The average balance of loans increased $28.7 million or 9.8% to $323.4 million for the nine months ended March 31, 2024, while the average rate increased 65 basis points to 4.51%. The average balance of interest-bearing liabilities increased $28.5 million or 10.7% to $293.9 million for the nine months just ended, and the average rate paid increased 190 basis points to 3.06%. The cost of liabilities increased rapidly due to higher costs of both wholesale and retail funding. Continued increases in liability costs, especially for wholesale funds, will primarily be driven by future increases in market rates by the Federal Reserve. It is widely believed that we are near the peak of this rate cycle which, if so, will likely slow the increasing costs of our liabilities. Net interest spread decreased from 2.66% for the prior year quarterly period to 1.46% for the nine-month period ended March 31, 2024. Provision for (Recovery of) Credit Losses Management determined that a $13,000 recovery of credit losses was prudent in light of the strengthening loan portfolio overall during the recently ended nine-month period. Impaired loans are now being individually evaluated for specific loss allocation and are therefore excluded from the homogeneous pooled loss analysis. The result is a more targeted representation of currently expected credit losses on loans. 34 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, 2024 and 2023 (continued) Non-interest Income Non-interest income decreased $37,000 or 15.7% to $199,000 for the nine months ended March 31, 2024, compared to the prior year period, primarily because of a decrease in other non-interest income, which is comprised of various items including bank-related fees and services. Non-interest Expense Non-interest expense increased $273,000 or 4.6% to $6.1 million for the nine months ended March 31, 2024, primarily due to higher outside service fee, FDIC insurance premiums, as well as higher employee compensation and benefits. Outside service fee expense increased $103,000 or 56.9% and totaled $284,000 due to additional professional expenses and costs associated with them. FDIC insurance premiums expense increased $101,000 or 160.3% and totaled $164,000 due to the FDIC increasing premiums throughout the industry in their effort to get the Deposit Insurance Fund closer to the statutory minimum of 1.35%. The ratio dipped after the recent bank failures of Silicon Valley Bank and Signature Bank. Employee compensation and benefits expense increased $64,000 or 1.7% and totaled $3.8 million for the nine months just ended due to additional salary expense. Income Tax Expense (Benefit) Income tax expense decreased $483,000 or 170.7% to an income tax benefit of $200,000 for the nine months ended March 31, 2024, compared to the prior year period due to decreased earnings. The effective tax rates for the nine-month periods ended March 31, 2024 and 2023, were 23.7% and 24.1%, respectively. Comparison of Operating Results for the Three-month Periods Ended March 31, 2024 and 2023 General Net loss totaled $107,000 or ($0.01) diluted earnings per share for the three months ended March 31, 2024, a decrease of $251,000 or 174.3% from net income of $144,000 or $0.02 diluted earnings per share for the same period in 2023. The decrease in net earnings for the quarter ended March 31, 2024, was primarily attributable to lower net interest income, and higher non-interest expense, which were partially offset by lower income taxes. 35 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Net Interest Income Net interest income decreased $280,000 or 13.7% to $1.8 million due primarily to interest expense increasing more than interest income increased period to period. Interest expense increased $1.2 million or 106.7%, while interest income increased $963,000 or 30.0% to $4.2 million for the recently-ended quarter. During the unprecedented interest rate increases seen in the market since March 2022, our funding sources have repriced more quickly than our assets have repriced, which has had a negative impact on net interest income. The average rate earned on interest-earning assets increased 75 basis points to 4.67% and was the primary reason for the increase in interest income, although average interest-earning assets also increased $30.0 million or 9.2% to $357.1 million for the recently-ended quarterly period. The increase in interest income was due primarily to an increase of $858,000 or 28.8% in interest income from loans, which totaled $3.8 million for the period. The increase in interest income from loans period-to-period was due to increases in both the average balance of loans and the average rate earned on those loans. The average balance of loans increased $24.4 million or 8.0% to $328.4 million for the three months ended March 31, 2024, while the average rate increased 75 basis points to 4.68%. The average balance of interest-bearing liabilities increased $28.8 million or 10.6% to $301.5 million for the quarter just ended, and the average rate paid increased 149 basis points to 3.19%. The cost of liabilities increased rapidly due to higher costs of both wholesale and retail funding. Continued increases in liability costs, especially for wholesale funds, will primarily be driven by future increases in market rates by the Federal Reserve. It is widely believed that we are near the peak of this rate cycle which, if so, will likely slow the increasing costs of our liabilities. Net interest spread decreased from 2.22% for the prior year quarterly period to 1.48% for the three-month period ended March 31, 2024. Provision for (Recovery of) Credit Losses Management determined that a $28,000 recovery of credit losses was prudent in light of the strengthening loan portfolio overall during the recently ended three-month period. Impaired loans are now being individually evaluated for specific loss allocation and are therefore excluded from the homogeneous pooled loss analysis. The result is a more targeted representation of currently expected credit losses on loans. Comparison of Operating Results for the Three-month Periods Ended March 31, 2024 and 2023 (continued) Non-interest Income Non-interest income increased $9,000 or 13.0% to $78,000 for the recently ended quarter primarily due to net gain on sales of loans, which increased from $0 to $8,000 for the three months ended March 31, 2024. Non-interest Expense Non-interest expense increased $100,000 or 5.2% and totaled $2.0 million for the three months ended March 31, 2024, primarily due to increased auditing and accounting expense, FDIC insurance premiums and other various bank expenses. Income Tax Expense (Benefit) Income taxes decreased $92,000 or 170.4% from an expense of $58,000 for the three months ended March 31, 2023, to a benefit of $38,000 for the recently ended period. The effective tax rates for the three-month periods ended March 31, 2024 and 2023, were 26.2% and 27.3%, respectively. 36 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.