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 ability to fully and timely address the deficiencies that resulted in the Agreement that First Federal Savings Bank of Kentucky has entered into with the Office of the Comptroller of the Currency (“OCC”); First Federal Savings Bank of Kentucky’s ability to satisfy the Individual Minimum Capital Requirements imposed by the OCC; 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; the ability of First Federal MHC to receive approval of its members to waive the payment of any Company dividends to First Federal MHC; 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, 2024. 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. General The Company was incorporated as a mid-tier holding company under the laws of the United States on March 2, 2005, upon the completion of the reorganization of First Federal of Hazard into a federal mutual holding company form of organization (the “Reorganization”). On that date, Kentucky First Federal also completed its minority stock offering and its concurrent acquisition of Frankfort First Bancorp, Inc. (“Frankfort First Bancorp”) and its wholly owned subsidiary, First Federal of Kentucky, Frankfort Kentucky (“First Federal of Kentucky”) (the “Merger”). Following the Reorganization and Merger, the Company has operated First Federal of Hazard and First Federal of Kentucky (collectively, the “Banks”) as two independent, community-oriented savings institutions. On December 31, 2012, the Company acquired CKF Bancorp, Inc., a savings and loan holding company which operated three banking locations in Boyle and Garrard Counties in Kentucky. In accounting for the transaction, the assets and liabilities of CKF Bancorp were recorded on the books of First Federal of Kentucky in accordance with accounting standard ASC 805, Business Combinations. Our results of operations are dependent primarily on net interest income, which is the difference between the income earned on our loans and securities and our cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by the provision for losses on loans and service charges and fees collected on our deposit accounts. Our general, administrative, and other expense primarily consists of employee compensation and benefits expense, occupancy and equipment expense, data processing expense, other operating expenses and state and federal income taxes. Results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities. 27 Kentucky First Federal Bancorp Regulatory Developments Regarding First Federal of Kentucky On August 13, 2024, First Federal of Kentucky entered into a formal written agreement (the “Agreement”) with the OCC, which became effective as of the same date. The Agreement will remain effective until it is amended by First Federal of Kentucky and the OCC, or the OCC modifies, waives or terminates the Agreement. As a result of the Agreement, pursuant to 12 C.F.R. § 5.51(c)(7)(ii), First Federal of Kentucky is in “troubled condition,” and is not an “eligible savings association” for purposes of 12 C.F.R. § 5.3, unless otherwise informed in writing by the OCC. In addition to the Agreement, the OCC has also imposed individual minimum capital requirements (“IMCRs”) on First Federal of Kentucky. The IMCRs require First Federal of Kentucky to maintain a common equity tier 1 capital ratio of at least 9.0%, a tier 1 capital ratio of at least 11.0%, a total capital ratio of at least 12.0%, and a leverage ratio of at least 9.0%. Under the terms of the Agreement, First Federal of Kentucky is required to take the following actions within the time frames specified in the Agreement: ● create a compliance committee composed of at least three of First Federal of Kentucky’s directors to monitor and oversee First Federal of Kentucky’s compliance with the provisions of the Agreement and submit quarterly evaluation reports to First Federal of Kentucky’s board of directors regarding actions First Federal of Kentucky has taken to comply with the Agreement and the results and status of such actions; ● submit to the OCC, adopt and implement an acceptable revised written three-year strategic plan establishing objectives for First Federal of Kentucky’s overall risk profile, balance sheet mix, funding structure, interest rate risk, liquidity and capital adequacy, earnings performance, and asset and core deposit growth, together with strategies to achieve those objectives; ● submit to the OCC, adopt and implement an acceptable revised written succession plan for First Federal of Kentucky that is designed to promote adequate staffing and continuity of capable management; ● adopt a revised written liquidity risk management program for First Federal of Kentucky that provides for the identification, measurement, monitoring, and control of First Federal of Kentucky’s liquidity risk exposure, and that emphasizes the importance of cash flow projections, diversified funding sources, a cushion of highly liquid assets, robust liquidity stress testing scenario analyses, and a formal, well-developed contingency funding plan as primary tools for measuring and managing liquidity risk; and ● adopt a revised written interest rate risk program that includes risk management systems to identify, measure, monitor, and control interest rate risk. The Agreement requires First Federal of Kentucky’s Board to (i) ensure that First Federal of Kentucky timely adopts and implements all corrective actions required by the Agreement and (ii) verify that First Federal of Kentucky adheres to the corrective actions and that they are effective in addressing First Federal of Kentucky’s deficiencies that resulted in the Agreement. First Federal of Kentucky’s Board and management are committed to fully addressing the provisions of the Agreement within the required time frames. As of the date of this filing, First Federal of Kentucky’s Board and management believe that First Federal of Kentucky has made progress toward addressing the deficiencies that resulted in the Agreement and intends to satisfy the Agreement’s requirements as expeditiously as possible. For additional information, see Exhibit 10.1 to the Company Current Report on Form 8-K filed with the Securities and Exchange Commission on August 15, 2024 and Item 1A, “Risk Factors - We are required to comply with the terms of a formal written agreement and IMCRs issued by the OCC, and lack of compliance could result in monetary penalties and /or additional regulatory actions ” and Note K - Stockholders’ Equity and Regulatory Capital of the Notes to Consolidated Financial Statements included in Item 8 of the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on October 3, 2024 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 September 30, 2023, we believe our risk associated with rising interest rates was moderate. Our IRR model indicated that at June 30, 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 June 30, 2023 EVE is anticipated to be approximately 14.6% and 11.9% 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 three-month periods ended September 30, 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 September 30, 2024 2023 Average Balance Interest And Dividends Yield/ Cost Average Balance Interest And Dividends Yield/ Cost (Dollars in thousands) Interest-earning assets: Loans 1 $ 335,985 $ 4,265 5.08 % $ 318,541 $ 3,459 4.34 % Mortgage-backed securities 9,714 81 3.34 11,924 99 3.32 Other interest-earning assets 20,062 274 5.46 11,878 176 5.93 Total interest-earning assets 365,761 4,620 5.05 342,343 3,734 4.36 Less: Allowance for loan losses (2,130 ) (1,627 ) Non-interest-earning assets 12,347 12,194 Total assets $ 375,978 $ 352,910 Interest-bearing liabilities: Demand deposits $ 15,731 $ 9 0.23 % $ 17,887 $ 8 0.18 % Savings 48,292 50 0.41 56,332 57 0.41 Certificates of deposit 176,547 1,876 4.25 149,812 1,151 3.07 Total deposits 240,570 1,935 3.22 224,031 1,216 2.17 Borrowings 68,897 815 4.73 63,120 848 5.37 Total interest-bearing liabilities 309,467 2,750 3.55 287,151 2,064 2.87 Noninterest-bearing demand deposits 16,198 13,225 Noninterest-bearing liabilities 2,284 2,197 Total liabilities 327,949 302,573 Shareholders’ equity 48,029 50,337 Total liabilities and shareholders’ equity $ 375,978 $ 352,910 Net interest spread $ 1,870 1.50 % $ 1,670 1.49 % Net interest margin 2.05 % 1.95 % Average interest-earning assets to average interest-bearing liabilities 118.19 % 119.22 % 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) Discussion of Financial Condition Changes from June 30, 2024 to September 30, 2024 Financial Position and Results of Operations At September 30, 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 Company in its Current Report on Form 8-K filed on August 15, 2024, in addition to the formal written Agreement, the OCC has also imposed individual minimum capital requirements (“IMCRs”) on First Federal Savings Bank of Kentucky. The IMCRs require First Federal Savings Bank of Kentucky to maintain a common equity tier 1 capital ratio of at least 9.0%, a tier 1 capital ratio of at least 11.0%, a total capital ratio of at least 12.0%, and a leverage ratio of at least 9.0%. As of September 30, 2024, First Federal Savings Bank of Kentucky’s common equity tier 1 capital ratio was 16.11%, its tier 1 capital ratio was 16.11%, its total capital ratio was 16.11%, and its leverage ratio was 10.07%. Assets: At September 30, 2024, the Company’s assets totaled $375.7 million, an increase of $682,000, or 0.2%, from total assets at June 30, 2024, due primarily to the increase in loans held for sale, as well as an increase in cash and due from financial institutions of $963,000 or 50.3%. Cash and cash equivalents: Cash and cash equivalents overall decreased $1.0 million or 5.6% to $17.3 million at September 30, 2024. Most of the Company’s cash and cash equivalents are held in interest-bearing demand deposits. Investment securities: At September 30, 2024, our securities portfolio, which consisted of mortgage-backed securities, decreased $246,000 or 2.5% and totaled $9.6 million, compared to June 30, 2024. Loans : Loans, net and loans held-for-sale in the aggregate increased $1.5 million or 0.5% and totaled $333.2 million and $1.5 million, respectively at September 30, 2024. Loans receivable, net, increased by $150,000 or 0.1% to $333.2 million at September 30, 2024. Loans held-for-sale increased to $1.4 million at September 30, 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. Because market interest rates have become more favorable, the Company has had more success in selling mortgages into the secondary market, which has led to an increase in loans held-for-sale. Non-Performing and Classified Loans: At September 30, 2024, the Company had non-performing loans (loans 90 or more days past due or on nonaccrual status) of approximately $4.3 million, or 1.3% of total loans compared to $3.9 million or 1.2%, of total loans at June 30, 2024. The Company’s ACL totaled $2.1 million at September 30, 2024 and the ACL totaled $2.1 million at June 30, 2024, respectively. The ACL at September 30, 2024, represented 50.2% of nonperforming loans and 0.6% of total loans, while at June 30, 2023, ALLL represented 54.6% of nonperforming loans and 0.6% of total loans. The Company had $6.6 million in assets classified as substandard for regulatory purposes at September 30, 2024, including real estate owned (“REO”) of $10,000. Classified loans as a percentage of total loans (including loans acquired) was 2.0% and 2.1% at September 30, 2024 and June 30, 2024, 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, 2024 June 30, 2024 Substandard assets $ 6,588 $ 7,171 Doubtful assets – – Loss assets – – Total classified assets $ 6,588 $ 7,171 At September 30, 2024, the Company’s real estate acquired through foreclosure represented 0.2% of substandard assets compared to 0.1% at June 30, 2024. 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, 2024 and June 30, 2024, respectively. 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, 2024 to September 30, 2024 (continued) The following table presents the aggregate carrying value of REO at the dates indicated: September 30, 2024 June 30, 2024 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, 2024 and June 30, 2024, the Company had $785,000 and $797,000 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 $456,000, or 0.1% to $327.4 million at September 30, 2024, as Federal Home Loan Bank advances increased $1.1 million or 1.5% to $70.1 million and advances to borrowers for taxes and insurance increased $333,000 or 36.6%. Certificates of deposit decreased $350,000 or 0.2% and totaled $176.2 million at September 30, 2024, of which $46.0 million were brokered deposits. Demand deposit accounts decreased $753,000 or 2.3% and totaled $31.4 million at quarter end. Savings accounts decreased $121,000 or 0.3% and totaled $47.3 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 September 30, 2024, the Company’s shareholders’ equity totaled $48.2 million, a, increase of $226,000 or 0.5% from the June 30, 2024. The increase in shareholders’ equity was primarily associated with accumulated other comprehensive loss decreasing $226,000 or 71.7% from a loss of $336,000 at June 30, 2024 to a loss of $95,000 at September 30, 2024. On January 16, 2024, the Company announced the suspension of quarterly dividends indefinitely. Holders of our common stock are only entitled to receive such dividends as our Board of Directors may declare out of funds available for such payments under applicable law and regulatory guidance. We cannot predict when or whether the Company will be able to pay future common stock dividends and if so, the amount of any such common stock dividends. Our ability to pay future dividends and if so at what level will also be dependent on numerous factors, including: 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; our ability to fully and timely address the deficiencies that resulted in the Agreement that First Federal Savings Bank of Kentucky has entered into with the OCC; First Federal Savings Bank of Kentucky’s ability to satisfy the IMCR’s imposed by the OCC; the ability of First Federal MHC to receive approval of its members to waive the payment of any Company dividends to First Federal MHC; and 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. See “Risk Factors” in Part II, Item 1A, of the Company’s Annual Report on Form 10-K for the year ended June 30, 2024 for additional discussion regarding dividends. 31 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, 2024 and 2023 General Net loss totaled $15,000 or ($0.00) diluted earnings per share for the three months ended September 30, 2024, an increase of $160,000 or 91.4% from net loss of $175,000 or ($0.02) diluted earnings per share for the same period in 2023. The decrease in net loss for the quarter ended September 30, 2024, was primarily attributable to increased net interest income, and higher non-interest income, which were partially offset by lower income tax benefit. Net Interest Income Net interest income increased $200,000 or 12.0% to $1.9 million due primarily to interest income increasing more than interest expense increased period to period. Interest income increased $886,000 or 23.7%, while interest expense increased $686,000 or 33.2% to $2.8 million for the recently-ended quarter. Over the last two years, the repricing of many of our assets has been slowed by contractual limits on rate changes, whereas the cost of most liabilities did not have this constraint. As market rates have steadied and even fallen slightly, the increase in cost of liabilities has slowed while we have begun to see our increase in interest income be greater than our increase in interest expense. The average rate earned on interest-earning assets increased 69 basis points to 5.05% and was the primary reason for the increase in interest income, although average interest-earning assets also increased $23.4 million or 6.8% to $365.8 million for the recently-ended quarterly period. The increase in interest income was due primarily to an increase of $806,000 or 23.3% in interest income from loans, which totaled $4.3 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 $17.4 million or 5.5% to $336.0 million for the three months ended September 30, 2024, while the average rate increased 73 basis points to 5.08%. Although the average balance of interest-bearing liabilities increased $22.3 million or 7.8% to $309.5 million for the quarter just ended, the average rate paid increased 68 basis points to 3.55%. The cost of liabilities increased rapidly due to higher costs of both wholesale and retail funding. We have seen interest rate changes slow and even decrease, allowing the repricing of our liabilities to do the same. Net interest spread increased from 1.49% for the prior year quarterly period to 1.50% for the three-month period ended September 30, 2024. Provision for Credit Losses Management determined that a $15,000 provision for credit loss was prudent in light of the slight increase in the loan portfolio during the recently-ended quarter. 32 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, 2024 and 2023 (continued) Non-interest Income Non-interest income increased $63,000 or 85.1% to $137,000 for the three months ended September 30, 2024, compared to the prior year period, primarily because of an increase in net gains on sales of loans as the demand for fixed rate loans has increased in the quarter recently ended. Non-interest Expense Non-interest expense increased $31,000 or 1.6% and totaled $2.0 million for the three months ended September 30, 2024, primarily due to increased data processing charges and increased FDIC insurance premiums. Data processing costs increased $31,000 or 23.3% and totaled $164,000 due to higher fees associated with expanded technology services offered to customers. FDIC insurance premiums increased $28,000 or 80.0% and totaled $63,000 due to overall higher rates. First Federal Savings Bank of Kentucky also expects higher FDIC insurance costs due to the Agreement with the OCC. The continued use of brokered deposits will also cause increased FDIC insurance costs. Income Tax Benefit Income tax benefit decreased $63,000 or 91.3% from a benefit of $69,000 for the three months ended September 30, 2023, to a benefit of $6,000 for the recently-ended period. The effective tax rates for the three-month periods ended September 30, 2024 and 2023 were 28.6% and 28.3%, respectively. 33 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.