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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the Fiscal Year Ended June 30, 1997.
[ ] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from___________to_________
Commission File Number: 0-18832
FIRST FEDERAL FINANCIAL CORPORATION OF KENTUCKY
(Exact name of registrant as specified in its charter)
Kentucky 61-1168311
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
2323 Ring Road, Elizabethtown, Kentucky 42701
(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code: (502) 765-2131
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $1.00 per share
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past ninety days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the outstanding voting stock held by
non-affiliates of the registrant, based on the closing sales price of the
Registrant's Common Stock as quoted on the National Association of Securities
Dealers, Inc. Automated Quotation National Market System on August 29, 1997, was
$89,680,714. Solely for purposes of this calculation, the shares held by
directors and executive officers of the registrant and by any stockholder
beneficially owning more than 5% of the registrant's outstanding common stock
are deemed to be shares held by affiliates.
As of August 29, 1997, there were issued and outstanding 4,171,196
shares of the registrant's common stock, of which directors and executive
officers held 473,603 shares and more than 5% beneficial owners held 307,595
shares.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Proxy Statement for the 1997 Annual Meeting of
Stockholders. (Part III)
PART I
Item 1. Business
The Corporation
First Federal Financial Corporation of Kentucky (the "Corporation") was
incorporated in August 1989 under the laws of the Commonwealth of Kentucky for
the purpose of becoming the holding company for First Federal Savings Bank of
Elizabethtown ("First Federal" or the "Bank") pursuant to the Bank's
reorganization into the holding company form of ownership, which was consummated
on June 1, 1990. Prior to its acquisition of all the outstanding stock of the
Bank in connection with the Bank's holding company reorganization, the
Corporation had no assets or liabilities and engaged in no business activities.
Since its acquisition of First Federal, the Corporation has engaged in no
significant activity other than holding the stock of First Federal and operating
the business of a savings bank through First Federal. Accordingly, the
information set forth in this report, including financial statements and related
data, relates primarily to First Federal and its subsidiary.
The Corporation's executive offices are located at 2323 Ring Road,
Elizabethtown, Kentucky. Its telephone number is (502) 765-2131.
The Bank
First Federal is a federally-chartered savings bank headquartered in
Elizabethtown, Kentucky. The business of First Federal consists primarily of
attracting deposits from the general public and originating mortgage loans on
single family residences, and to a lesser extent on multi-family housing and
commercial property. First Federal also makes home improvement loans, consumer
loans and commercial business loans and through its subsidiary offers insurance
products and brokerage services to its customers. In April 1993 the Bank
established a full service trust department to serve the fiduciary needs of its
customers. The principal sources of funds for First Federal's lending activities
include deposits received from the general public, borrowings from the Federal
Home Loan Bank of Cincinnati, principal amortization and prepayment of loans.
First Federal's primary sources of income are interest and origination fees on
loans and interest on investments. First Federal also invests in various federal
and government agency obligations and other investment securities permitted by
applicable laws and regulations. First Federal's principal expenses are interest
paid on deposit accounts and operating expenses.
First Federal was originally founded in 1923 as a state-chartered
institution and became federally-chartered in 1940. In 1987, the Bank converted
to a federally-chartered savings bank and converted from mutual to stock form.
The Bank is a member of the Federal Home Loan Bank ("FHLB") of
Cincinnati and is subject to regulation, examination and supervision by the
Office of Thrift Supervision ("OTS"). The Bank's deposits are insured by the
Savings Association Insurance Fund ("SAIF") administered by the Federal Deposit
Insurance Corporation("FDIC").
Lending Activities
General. The principal lending activity of First Federal is the origination
of conventional first mortgage loans secured by residential property. To a
lesser extent the Bank engages in commercial real estate, consumer and
commercial business lending. Residential mortgage loans made by First Federal
are secured primarily by single family homes and include construction loans. The
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majority of First Federal's mortgage loan portfolio is secured by real estate
located in Hardin, Nelson, Hart, Meade, LaRue, and Bullitt counties in the state
of Kentucky.
Loan Underwriting Policies. During the loan approval process, First
Federal assesses both the borrower's ability to repay the loan and the adequacy
of the underlying security. Potential residential borrowers complete an
application which is submitted to a salaried loan officer. As part of the loan
application process, qualified fee appraisers inspect and appraise the property
which is offered to secure the loan. The Bank also obtains information
concerning the income, financial condition, employment and credit history of the
applicant. First Federal's loan committee, consisting of certain officers of the
Bank, analyzes the loan application and the property to be used as collateral
and subsequently approves or denies the loan request. If the mortgage loan
amount is less than $250,000, it must be approved by a loan committee consisting
of certain members of management. The Board of Directors must approve all
mortgage loans in excess of $250,000. All consumer loans under $25,000 may be
approved by authorized loan officers under Board approved lines of authority and
all loans under $100,000 may be approved by an officer loan committee. Consumer
loans in excess of $100,000 must be approved by the President. In connection
with the origination of single family residential adjustable rate mortgage
loans, borrowers are qualified at a rate of interest equal to the fully accrued
index rate. It is the policy of management to make loans to borrowers who not
only qualify at the low initial rate of interest, but who would also qualify
following an upward interest rate adjustment.
2
Loan Portfolio Analysis. Set forth below is selected data relating to the
composition of the Bank's loan portfolio by type of loan and type of security on
the date indicated.
June 30,
1997 1996 1995 1994 1993
------ ------ ------- ------- ------
Amount % Amount % Amount % Amount % Amount %
-------- --- ------- --- -------- -- -------- --- -------- ---
(Dollars in thousands)
Type of Loan:
Conventional real estate
loans:
Interim construction
loans ................... $ 15,444 4.71% $ 15,766 2.88% $ 8,159 2.88% $ 7,007 3.03% $ 8,227 3.79%
Loans on existing
property.......................217,759 66.43 204,301 69.06 195,424 69.06 146,228 63.35 136,047 62.78
Loans refinanced..................67,693 20.65 65,681 21.48 60,765 21.48 62,724 27.17 57,010 26.30
Commercial loans secured by
real estate........................2,246 .69 2,406 .71 2,004 .71 3,234 1.40 4,551 2.10
Commercial lines of credit...........1,953 .60 1,785 .40 1,138 .40 721 .31 1,140 .52
Home equity loans...................10,377 3.16 4,959 1.35 3,802 1.35 3,675 1.59 3,120 1.44
Consumer loans:
Mobile home loans.................... 18 .01 49 .02 51 .02 47 .02 125 .06
Education loans..................... 0 .00 0 .00 0 .00 0 .00 14 .01
Savings account loans..............1,667 .51 1,597 .48 1,357 .48 823 .35 1,424 .66
Home improvement loans................ 2 .00 108 .01 44 .01 107 .04 405 .19
Automobile, boat and
recreational vehicle
loans.............................. 338 .10 805 .35 980 .35 1,019 .44 1,363 .63
Other.............................22,390 6.83 19,649 6.89 19,504 6.89 14,298 6.19 11,818 5.45
Accrued interest
receivable..........................179 .05 187 .05 146 .05 133 .05 83 .04
Less:
Loans in process...................7,098 2.17 10,156 2.00 5,671 2.00 5,503 2.38 4,894 2.26
Discounts and other...................61 .02 184 .10 272 .10 285 .12 549 .25
Loan loss reserve..................1,715 .52 1,613 .59 1,661 .59 1,406 .61 1,415 .65
Deferred loan fees................ 2,672 .81 2,329 .72 2,052 .72 1,804 .78 1,586 .73
Escrow deposits..................... 683 .21 618 .26 730 .26 225 .10 160 .07
Interest reserves (91 days
or more delinquent)..................46 .01 30 .01 34 .01 13 .01 28 .01
------- ------ -------- ------ ------- ------ -------- ------- ------ ------
Total.....................$327,791 100.00% $302,363 100.00% $282,954 100.00% $230,793 100.00% $216,695 100.00%
======= ====== ======== ======= ======== ====== ======= ======= ======= ======
3
June 30,
1997 1996 1995 1994 1993
---------------- ----------------- ---------------- ---------------- ----------------
Amount % Amount % Amount % Amount % Amount %
-------- ----- -------- ----- -------- ------ -------- ----- -------- ---
(Dollars in thousands)
Type of Security:
Residential
Single family................. $267,839 81.71% $249,161 82.40% $230,672 81.52% $188,559 81.70% $173,741 80.17%
2-to-4 family.................. 5,983 1.82 6,554 2.17 5,846 2.07 5,268 2.28 5,843 2.70
Other dwelling................. 6,055 1.85 6,332 2.09 6,296 2.22 5,662 2.45 6,138 2.83
Commercial or industrial......... 24,482 7.47 30,169 9.98 25,570 9.03 21,768 9.43 21,774 10.04
Home equity...................... 10,377 3.16 4,959 1.64 3,802 1.35 3,675 1.59 3,120 1.44
Savings Accounts................. 1,667 .51 1,597 .52 1,357 .48 823 .36 1,424 .66
Mobile Homes..................... 18 .01 49 .02 51 .02 47 .02 125 .06
Automobile, boats and
recreational vehicles.......... 338 .10 805 .27 980 .35 1,019 .44 1,363 .63
Other............................ 23,128 7.06 17,480 5.78 18,654 6.59 13,075 5.67 11,716 5.40
Accrued interest
receivable.................... 179 .05 187 .06 146 .05 133 .06 83 .04
Less:
Loans in process............... 7,098 2.17 10,156 3.36 5,671 2.00 5,503 2.38 4,894 2.26
Discounts and other............ 61 .02 184 .06 272 .10 285 .12 549 .25
Loan loss reserve.............. 1,715 .52 1,613 .53 1,661 .59 1,406 .61 1,415 .65
Deferred loan fees............. 2,672 .81 2,329 .77 2,052 .72 1,804 .78 1,586 .73
Escrow deposits................ 683 .21 618 .20 730 .26 225 .10 160 .07
Interest Reserves (91
days or more
delinquent)................ 46 .01 30 .01 34 .01 13 .01 28 .01
------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total.....................$327,791 100.00% $282,954 100.00% $230,793 100.00% $230,793 100.00% $216,695 100.00%
======= ====== ======== ====== ======== ====== ======== ====== ======== ======
Loan Maturity Schedule. The following table sets forth certain
information at June 30, 1997, regarding the dollar amount of loans
maturing in the Bank's loan portfolio based on their contractual terms
to maturity.
Due after
Due During 1 through Due after 5
the year ended 5 years after years after
June 30, June 30, June 30,
1998 1997 1997
(Dollars in thousands)
Real estate mortgage.......... $ 1,557 $ 9,024 $274,111
Real estate construction (1)......... 0 0 8,435
Installment......................... 133 542 1
Commercial, financial and
agricultural................... 7,922 30,325 918
-------- -------- --------
Total.................... $ 9,612 $ 39,891 $283,465
======== ======== ========
(1) These loans will become permanent real estate loans upon completion of
construction.
4
The following table reflects a breakdown of loans maturing after one year, by
predetermined rates and adjustable rates.
Predetermined Floating or
Rates Adjustable Rates Total
(Dollars in thousands)
Real estate mortgage ................ $177,946 $105,166 $283,112
Real estate construction.................3,979 4,457 8,436
Installment................................543 0 543
Commercial, consumer and
agricultural..........................17,228 14,037 31,265
------- ------- -------
Total.........................$199,696 $123,660 $323,356
======= ======= =======
Residential Real Estate Lending. The Bank's primary lending activity is
the origination of loans on single family residential units, which are units
consisting of one-to-four individual dwelling units. Fixed rate residential real
estate loans originated by the Bank have terms ranging from ten to thirty years.
Interest rates are competitively priced within the primary geographic lending
market, and vary according to the term for which they are fixed.
In recent years, the Bank has emphasized the origination of
adjustable-rate mortgage loans ("ARMs"). The Bank offers an ARM with an annual
adjustment which is tied to various national indeces with a maximum adjustment
of 2% annually and a lifetime cap of 15%. As of June 30, 1997, approximately 37%
of the Bank's real estate loans were adjustable rate loans with adjustment
periods ranging from one to five years and balloon loans of seven years or less.
The Bank limits the maximum loan-to-value ratio on one-to-four-family
residential first mortgages to 80% of the appraised value and 95% on certain
mortgages, with the requirement that private mortgage insurance be obtained for
loans with loan-to-value ratios in excess of 80%. The Bank generally limits the
loan-to-value ratio to 80% on second mortgages on one-to-four-family dwellings.
First Federal's residential lending activities also include loans
secured by multi-family residential property, consisting of properties with more
than four separate dwelling units. These loans amounted to $6.1 million or 1.9%
of the loan portfolio at June 30, 1997. First Federal generally does not lend
above 75% of the appraised values of multi-family residences on first mortgage
loans. The mortgage loans First Federal currently offers on multi-family
dwellings are generally one or five year ARMs with maturities of 25 years or
less.
The Bank maintains a secondary mortgage operation designed to make
qualified VA and FHA loans for sale to investors, thereby providing necessary
liquidity to the Bank and needed loan products to the Bank's customers. During
fiscal 1997, the Bank's secondary mortgage operations originated $18.2 million
in loans for sale to investors.
Construction and Commercial Real Estate Lending. First Federal
originates loans secured by existing commercial properties and construction
loans primarily on residential real estate. The loans are secured by real estate
located in Kentucky. Substantially all of the commercial real estate loans
originated by First Federal have adjustable interest rates with maturities of 25
years or less or are loans with fixed interest rates and maturities of five
years or less. At June 30, 1997, the Bank had $15.4 million in outstanding
interim construction loans. The security for commercial real estate loans
includes retail businesses, warehouses and motels. Commercial real estate loans
originated by the Bank range
5
in size from $80,000 to $215,000.
Commercial real estate loans typically involve large loan balances to
single borrowers or groups of related borrowers and may also involve higher loan
principal amount to security property appraisal value ratios as compared to
loans secured by residential real estate. In addition, the payment experience of
loans secured by income producing properties is typically dependent on the
successful operation of the related real estate project and thus may be more
vulnerable to adverse conditions in the real estate market or in the economy
generally. Construction loans involve additional risks as a result of the fact
that loan funds are advanced upon the security of the project under
construction, which is of uncertain value prior to the completion of
construction. Moreover, because of the uncertainties inherent in estimating
construction costs, delays arising from labor problems, material shortages, and
other unpredictable contingencies, it is relatively difficult to evaluate
accurately the total loan funds required to complete a project, and related
loan-to-value ratios. The analysis of prospective construction loan projects
thus requires an expertise that varies in significant respects from that which
is required for residential mortgage lending.
The Bank's underwriting criteria are designed to evaluate and minimize
the risks of each construction loan. Among other things, the Bank considers
evidence of the availability of permanent financing or a takeout commitment to
the borrower; the reputation of the borrower and his or her financial condition;
the amount of the borrower's equity in the project; independent appraisals and
cost estimates; preconstruction sale and leasing information; and cash flow
projections of the borrower.
Consumer Loans. Federal regulations permit federally chartered thrift
institutions to make secured and unsecured consumer loans of up to 30% of their
assets. This limit may be exceeded for certain consumer loans, such as home
equity loans, property improvement loans, mobile home loans and loans secured by
savings accounts. The consumer loans granted by the Bank have included loans on
automobiles, boats, recreational vehicles and other consumer goods, as well as
education loans, loans secured by savings accounts, home improvement loans, and
unsecured lines of credit. As of June 30, 1997, consumer loans outstanding were
$39.0 million or approximately 11.8% of the Bank's total gross loan portfolio.
These loans involved a higher risk of default than loans secured by one-to-four-
family residential loans. The Bank believes, however, that the shorter term and
the normally higher interest rates available on various types of consumer loans
have been helpful in maintaining a profitable spread between the Bank's average
loan yield and its cost of funds.
In view of the riskier nature of consumer lending, the Bank has
developed what management believes are conservative underwriting standards. In
applying these standards, the Bank obtains detailed financial information and
credit bureau reports concerning each applicant. In addition, the relationship
of the loans to the value of the collateral is considered.
The Bank offers a home equity line of credit, which is a revolving line
of credit secured by the equity in a customer's home. As of June 30, 1997, these
loans totaled $10.4 million which is a 112% increase over the prior fiscal year.
Commercial Business Lending. The Bank is permitted to make secured and
unsecured loans for commercial, corporate, business, and agricultural purposes,
including issuing letters of credit and engaging in inventory financing and
commercial leasing activities. First Federal has offered business loans secured
by real estate since 1982 and it has not been a material part of the Bank's
activities to date. The Bank may become more active in this type of lending in
the future.
6
The Bank offers a commercial line of credit, which is a revolving line
of credit secured by the equity in the property, primarily real estate, of a
business. As of June 30, 1997, these loans totaled approximately $2.0 million.
Origination, Purchases and Sales. Historically, all residential and
commercial real estate loans have been originated directly by the Bank through
salaried loan officers. Residential loan originations are generally attributable
to referrals from real estate brokers and builders, depositors and walk-in
customers. Commercial real estate and construction loan origination have been
obtained by direct solicitation, and consumer loan origination by walk-in
customers in response to the Bank's advertising, as well as by direct
solicitation.
The following table shows loans originated and sold during the periods
indicated. No loans were purchased by the Bank during the last five fiscal
years.
Year Ended June 30,
1997 1996 1995 1994 1993
------- ------ ----- ------ -----
(Dollars in thousands)
Loans originated:
Conventional real estate
loans:
Construction loans................... $ 16,664 $ 16,078 $12,632 $15,093 $15,664
Loans on existing property...............47,256 61,349 38,235 33,216 35,834
Loans refinanced.........................15,846 16,436 5,271 17,923 18,172
Insured and guaranteed loans................2,286 2,472 1,936 1,705 2,679
Commercial loans........................... 2,769 3,267 2,331 5,129 3,493
Consumer loans.............................29,440 21,071 18,548 14,199 12,009
------- ------- ------- ------- -------
Total Loans Originated..............$114,261 $120,673 $78,953 $87,265 $87,851
======= ======= ======= ======= =======
Total Loans Sold.......................... $ 16,199 $ 23,178 $ 8,822 $ 4,121 $ 3,176
======= ======== ======= ======= =======
Loan Commitments. Conventional loan commitments by the Bank are granted
for periods of 30 days. The total amount of the Bank's outstanding commitments
to originate real estate loans at June 30, 1997, was approximately $6.2 million.
It has been the Bank's experience that few commitments expire unfunded.
Loan Fees. In addition to interest earned on loans, certain fees are
received for committing to and ultimately originating loans. The Bank also
receives other fees and charges relating to existing loans, which include
prepayment penalties, late charges and fees for loan modifications. Management
believes that these fees and charges do not materially affect operating results.
Non-Performing Loans and Asset Classification. Loans are reviewed on a
regular basis and normal collection procedures are implemented when a borrower
fails to make a required payment on a loan. If the delinquency on a mortgage
loan exceeds 90 days and is not cured through normal collection procedures or an
acceptable arrangement is not worked out with the borrower, the Bank institutes
measures to remedy the default, including commencing a foreclosure action.
Consumer loans generally are charged off when a loan is deemed uncollectible by
management and any available collateral has been disposed of. Commercial
business and real estate loan delinquencies are handled on an individual basis
by management with the advice of the Bank's legal counsel.
7
Real estate acquired by the Bank as a result of foreclosure or by deed
in lieu of foreclosure is classified as real estate owned until such time as it
is sold. When such property is acquired it is recorded at the lower of the
unpaid principal balance of the related loan or its fair market value. Any
write-down of the property is charged to the allowance for loan losses.
The following table sets forth information with respect to the Bank's
non-performing assets for the periods indicated. During the periods shown, the
Bank had no restructured loans within the meaning of Statement of Financial
Accounting Standards No. 15.
At June 30,
1997 1996 1995 1994 1993
------ ------ ------- ------ -----
(Dollars in thousands)
Non-Performing loans which are
contractually past due
90 days or more:
Real Estate:
Residential.....................$ 1,172 $ 940 $ 649 $ 254 $ 610
Commercial......................... -- -- -- -- --
Consumer............................. 378 312 512 333 343
------ ------- ------- ------- ------
Total...................... $ 1,550 $ 1,252 $ 1,161 $ 587 $ 953
======= ======= ======= ======= ======
Total 90 days past
due loans................$ 1,550 $ 1,252 $ 1,161 $ 587 $ 953
======= ======= ======= ======= ======
Percentage of Total Loans................ 0.47% 0.41% 0.41% 0.25% 0.44%
Other Non-Performing Assets $ 184 $ 375 $ 260 $ 267 $ 500
======= ======= ======= ======= ======
(1)..............................................
(1) Other non-performing assets represents property acquired by the Bank
through foreclosure or repossession. This property is carried at the
lower of its fair value or the principal balance of the related loan.
8
The following table sets forth an analysis of the Bank's allowance for
possible loan losses for the periods indicated.
Year Ended June 30,
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
(Dollars in thousands)
Balance at Beginning of Period...... $1,613 $1,662 $1,406 $1,415 $1,127
------ ------ ------ ------ ------
Loans Charged-Off:
Real Estate--Mortgage:
Residential..........................17 0 14 0 10
Commercial............................0 0 16 10 0
Commercial Business.................... 0 24 0 0 0
Consumer..............................114 50 21 35 15
------- ------ ------ ------ ------
Total Charge-Offs..................... 131 74 51 45 25
------ ------ ------ ------ ------
Recoveries:
Real Estate-Mortgage:
Residential...........................0 1 0 0 12
Commercial............................0 23 16 0 0
Consumer...............................33 1 6 6 6
------ ------ ------ ------ ------
Total Recoveries........................ 33 25 22 6 18
------ ------ ------ ------ ------
Net Loans Charged-Off................... 98 49 29 39 7
------ ------ ------ ------ ------
Reserve associated with loans
acquired in merger...................... -- -- 185 -- --
Provision for Possible Loan
Losses..................................200 0 100 30 295
------ ------ ------ ------ ------
Balance at End of Period.............$1,715 $1,613 $1,662 $1,406 $1,415
====== ====== ====== ====== ======
Ratio of Net Charge-Offs to
Average Loans Outstanding
During the Period................... 0.031% 0.017% 0.010% 0.017% 0.003%
The following table sets forth the breakdown of the allowance for loan
losses by loan category for the periods indicated. Management believes that the
allowance can be allocated by category only on an approximate basis. The
allocation of the allowance to each category is not necessarily indicative of
further losses and does not restrict the use of the allowance to absorb losses
in any category.
At June 30,
1997 1996 1995 1994 1993
------ ------- ------ ------ -----
(Dollars in thousands)
Real estate loans:
Residential Loans.........$1,178 $1,277 $1,289 $1,043 $1,012
Commercial Loans.............146 142 128 103 112
Non-real estate loans...........391 194 245 260 291
------ ------ ------ ------ ------
Total allowance for
possible loan
losses.................... $1,715 $1,613 $1,662 $1,406 $1,415
====== ====== ====== ====== ======
It is management's policy to provide for estimated losses on loans and
investments in real estate when it determines that losses are expected to be
incurred on the underlying assets. Management also establishes general
allowances based on the amount and types of loans in the Bank's portfolio.
Subsequent adjustments to allowances are made if current circumstances differ
substantially from the assumptions used in making the initial estimates.
At June 30, 1997, there were no concentrations of loans in any types of
industry which exceeded 10% of total loans that were not otherwise disclosed as
a loan category above. In addition, there were no loans which were not
classified as non-accrual or restructured at June 30, 1997 which may be so
classified in the near future because of management concerns as to the ability
9
of the borrowers to comply with repayment terms.
Federal regulations require insured institutions to classify their own
assets on a regular basis. In addition, in connection with examinations of
insured institutions, OTS examiners have authority to identify problem assets
and, if appropriate, classify them. The regulations provide for three
classifications of asset categories -- substandard, doubtful and loss. The
regulations also contain a special mention category, defined as assets which do
not currently expose an insured institution to a sufficient degree of risk to
warrant classification but do possess credit deficiencies or potential
weaknesses deserving management's close attention. Assets classified as
substandard or doubtful require the institution to establish general allowances
for loan losses. If an asset or portion thereof is classified as loss, the
insured institution must either establish specified allowances for loan losses
in the amount of 100% of the portion of the asset classified loss, or charge off
such amount.
At June 30, 1997, on the basis of management's review of the Bank's
loan portfolio, the Bank had $1.7 million of assets classified substandard, no
assets classified doubtful, and $18,000 of assets classified as loss.
Investment Activities
Interest on investment securities provides the largest source of income
for First Federal after interest on loans, constituting 6.1% of the total
interest income for fiscal year 1997. First Federal maintains its liquid assets
above the minimum requirements imposed by regulation at a level believed
adequate to meet requirements of normal banking activities and potential savings
outflows. Cash flow projections are regularly reviewed and updated to assure
that adequate liquidity is provided. As of June 30, 1997, First Federal's
liquidity ratio (liquid assets as a percentage of net withdrawable savings and
current borrowings) was 7.72%.
First Federal has the authority to invest in various types of liquid
assets, including short-term United States Treasury obligations and securities
of various federal agencies, certificates of deposit at insured savings and
loans and banks, bankers' acceptances, and federal funds. The Bank may also
invest a portion of its assets in certain commercial paper and corporate debt
securities. First Federal is also authorized to invest in mutual funds and
stocks whose assets conform to the investments that First Federal is authorized
to make directly. See Note 3 of Notes to Consolidated Financial Statements for
further information concerning the Bank's investment portfolio.
As a member of the Federal Home Loan Bank System, First Federal must
maintain minimum levels of liquid assets specified by the OTS which vary from
time to time. See "Regulation - Federal Home Loan Bank System." Liquidity may
increase or decrease depending upon the availability of funds and comparative
yields on investments in relation to return on loans.
The table on the following page sets forth the carrying value of the
Bank's investment securities portfolio at the dates indicated. At June 30, 1997,
the market value of the Bank's investment securities portfolio was $23 million.
10
At June 30,
1997 1996 1995
-------- -------- ------
(Dollars in thousands)
Held-to-maturity securities:
U.S. Treasury and agencies..........$15,335 $ 9,225 $ 9,132
Mortgage-backed securities............2,149 2,769 3,202
Tax exempt bond........................ 0 0 33
------- ------- -------
Total held-to-maturity
securities.........................$17,484 $11,994 $12,367
======= ======= =======
Securities available-for-sale:
Equity securities................. $ 5,192 $ 4,748 $ 4,701
======= ======= =======
The following table sets forth the scheduled maturities, amortized
cost, and average yields for the Bank's debt securities at June 30, 1997, all of
which were classified as held-to-maturity.
Amortized Average
Cost Yield
(Dollars in thousands)
Debt securities:
Due in one year or less.................... $ 735 5.73%
Due after one year through five years........12,852 6.79
Due after five years through ten years........1,748 5.64
Mortgage-backed securities................... 2,149 6.90
------
$17,484
=======
11
Sources of Funds
General. Savings accounts and other types of deposits have
traditionally been an important source of the Bank's funds for use in lending
and for other general business purposes. In addition to deposit accounts, the
Bank derives funds from loan repayments, FHLB advances, other borrowings and
operations. Borrowings may be used on a short-term basis to compensate for
reductions in deposits or deposit inflows at less than projected levels and may
be used on a longer term basis to support expanded lending activities.
Deposits. First Federal attracts both short-term and long-term deposits
from the general public by offering a wide range of deposit accounts and
interest rates. In recent years the Bank has been required by market conditions
to rely increasingly on short-term certificate accounts and other deposit
alternatives that are more responsive to market interest rates. First Federal
offers regular passbook accounts, NOW accounts, money market accounts and
fixed-interest-rate certificates with varying maturities. First Federal also
offers tax-deferred individual retirement accounts.
As of June 30, 1997, approximately 30.1% of First Federal's deposits
consisted of various savings and demand deposit accounts from which customers
are permitted to withdraw funds at any time without penalty.
Interest earned on passbook accounts is paid from the date of deposit
to the date of withdrawal and compounded quarterly. Interest earned on NOW
accounts is paid from the date of deposit to the date of withdrawal, compounded
and credited monthly. The interest rate on these accounts is established by
First Federal's management.
First Federal also makes available to its depositors a number of
certificates of deposit with various terms and interest rates to be competitive
in its market area. These certificates have minimum deposit requirements as
well.
12
The following table sets forth the change in dollar amount of savings deposits
in the various types of savings accounts offered by the Bank between the dates
indicated.
Balance Balance Balance Balance
June 30, % of Increase June 30, % of Increase June 30, % of Increase June 30, % of
1997 Deposits (Decrease) 1996 Deposits (Decrease) 1995 Deposits (Decrease) 1994 Deposits
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Passbook and
Regular Savings.....$ 31,186 11.08% $ (112) $ 31,298 11.81% $ (2,340) $ 33,638 12.91% $ 4,567 $ 29,071 14.75%
NOW commercial
accounts.............. 9,813 3.49 833 8,980 3.39 1,447 7,533 2.89 4,086 3,447 1.75
NOW Demand Accounts...33,140 11.78 2,702 30,438 11.49 735 29,703 11.40 9,598 20,105 10.20
Money Market
deposit accounts..... 10,460 3.72 191 10,269 3.88 1,629 8,640 3.32 (950) 9,590 4.86
Three month CD's.......1,033 .37 (64) 1,097 .41 (253) 1,350 .52 (514) 1,864 .95
Six month CD's....... 12,399 4.41 (5,132) 17,531 6.62 2,051 15,480 5.94 3,604 11,876 6.02
Fixed rate CD's
- 12 months........53,713 19.09 5,140 48,573 18.33 9,394 39,179 15.04 28,636 10,543 5.35
Variable rate CD's
- 12 months........ 3,119 1.11 (1,205) 4,324 1.63 (814) 5,138 1.97 (4,528) 9,666 4.90
Fixed Rate CD's
- 18 months........35,503 12.62 27,905 7.598 2.87 (6,929) 14,527 5.58 4,093 10,434 5.29
Fixed Rate CD's
- 24 months........24,985 8.88 (8,673) 33,658 12.70 5,004 28,654 11.00 5,494 23,160 11.75
Fixed Rate CD's
- 30 months........ 3,170 1.13 (605) 3,775 1.42 (3,861) 7,636 2.93 (616) 8,252 4.19
Fixed Rate CD's
- 36 months........11,702 4.16 (26) 11,728 4.43 (1,473) 13,201 5.07 7,142 6,059 3.07
Fixed Rate CD's
- 48 months........16,796 5.97 (5,502) 22,298 8.42 (1,278) 23,576 9.05 (2,635) 26,211 13.29
Variable Rate CD's
- 48 months.......... 28 .01 (7) 35 .01 (20) 55 .02 (38) 93 .05
IRA accounts..........23,046 8.19 1,242 21,804 8.23 1,267 20,537 7.88 4,645 15,892 8.06
Other accounts -
6 to 8 year CD's...11,249 3.99 (291) 11,540 4.36 (116) 11,656 4.48 776 10,880 5.52%
------- ------ ------- -------- ------ --------- -------- ------ ------ -------- -----
Total........$281,342 100.00% $16,396 $264,946 100.00% $ 4,443 $260,503 100.00% $ 63,360 $197,143 100.00%
======= ====== ======= ======== ====== ======== ======== ====== ======== ======== =======
13
The variety of deposit accounts offered by First Federal has permitted it
to be more competitive in obtaining funds and has allowed it to respond with
more flexibility to disintermediation (the flow of funds away from depository
institutions such as savings institutions into direct investment vehicles such
as government and corporate securities). However, the ability of the Bank to
attract and maintain deposits and its cost of funds have been, and will continue
to be, significantly affected by money market conditions.
The following table sets forth the amount of deposits as of June 30, 1997
by various interest rate categories.
Weighted
Average Percent
Interest Minimum Minimum of Total
Rate Term Category Amount Balances(1) Savings
2.65% NONE Passbook Savings Account $ 1 $ 31,186 11.08%
.20 NONE NOW Commercial Accounts 300 9,813 3.49
1.31 NONE NOW Demand Accounts 1,000 33,140 11.78
3.38 NONE Money Market Deposit Accounts 500 10,460 3.72
3.45 91 days 3 Month Certificate 500 1,033 0.37
4.41 182 days 6 Month Certificate 500 12,399 4.41
5.33 12 months Fixed Rate 500 53,713 19.09
4.88 12 months Variable Rate 500 3,119 1.11
6.05 18 months Fixed Rate 500 35,503 12.62
5.56 24 months Fixed Rate 500 24,985 8.88
5.79 30 months Fixed Rate 500 3,170 1.13
5.96 36 months Fixed Rate 500 11,702 4.16
5.74 48 months Fixed Rate 500 16,796 5.97
4.65 48 months Variable Rate 500 28 0.01
5.75 18 months Individual Retirement Accounts 500 23,046 8.19
6.30 6-8 years Other Certificates 500 11,249 3.99
------- ------
$281,342 100.00%
======== ======= ======
(1) Dollars in thousands.
14
The following table indicates at June 30, 1997 the amount of the Bank's
certificates of deposit of $100,000 or more by time remaining until maturity.
Maturity Period Certificates
of Deposit
(In Thousands)
Three months or less.................... $7,226
Three through six months................ 5,249
Six through twelve months............... 8,756
Over twelve months...................... 22,695
------
Total.............................. $43,926
======
The following table sets forth the average balances and interest rates
based on month-end balances for various deposit categories during the periods
indicated.
Year Ended June 30,
1997 1996 1995
--------------- --------------- ----------------
Average Average Average
Average Rate Average Rate Average Rate
Balance Paid Balance Paid Balance Paid
(Dollars in thousands)
Non interest-bearing
accounts...................$ 9,104 --% $ 8,376 --% $ 10,591 --%
Interest-bearing
demand deposits............. 42,343 1.70 37,489 1.65 29,020 1.58
Savings deposits...............31,259 2.62 31,885 2.65 31,224 2.59
Certificates of
deposit....................187,974 5.52 180,959 5.68 157,579 5.19
Borrowings. Savings deposits are the primary source of funds for First
Federal's lending and investment activities and for its general business
purposes. The Bank can also use advances (borrowings) from the FHLB of
Cincinnati to supplement its supply of lendable funds, meet deposit withdrawal
requirements and to extend the term of its liabilities. Advances from the FHLB
are typically secured by the Bank's stock in the FHLB and a portion of the
Bank's first mortgage loans. At June 30, 1997 First Federal had $41.5 million in
advances outstanding from the FHLB of Cincinnati.
The FHLB of Cincinnati functions as a central reserve bank providing
credit for savings banks and certain other member financial institutions. As a
member, First Federal is required to own capital stock in the FHLB and is
authorized to apply for advances on the security of such stock and certain of
its home mortgages and other assets (principally, securities which are
obligations of, or guaranteed by, the United States) provided certain standards
related to credit-worthiness have been met.
15
Average Balance Sheet
The following table sets forth information relating to the Bank's average
balance sheet and reflects the average yield on assets and average cost of
liabilities for the periods indicated. Such yields and costs are derived by
dividing income or expense by the average monthly balance of assets or
liabilities, respectively, for the periods presented.
Year Ended June 30,
1997 1996 1995
----------------------------- ----------------------------------- ----------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- -------- -------- --------- -------- -------- ------- -------- ------
(Dollars in thousands)
Interest-earning assets:
Loans-receivable, net......... $317,565 $ 26,945 8.48% $295,657 $ 25,173 8.51% $256,659 $ 21,287 8.29%
Debt securities................. 15,133 976 6.45 8,011 527 6.25 6,629 498 7.51
Equity securities.................4,856 228 4.70 4,536 225 4.96 4,260 173 4.06
Mortgage-backed securities........2,514 178 7.08 3,042 222 7.30 1,688 107 6.34
FHLB stock........................2,674 188 7.03 2,495 174 6.97 2,138 137 6.41
Interest-bearing deposits.........1,805 98 5.43 9,981 605 6.06 7,746 489 6.31
Total interest-earning -------- ------- ------ ------- -------- ----- -------- ------- ------
assets...................... 344,548 28,613 8.30 323,722 26,926 8.32 279,120 22,691 8.13
------- -------- -------
Non-interest-earning assets........21,981 18,906 15,761
------- -------- --------
Total assets................ $366,529 $342,628 $294,881
======= ======== ========
Interest-bearing liabilities:
Passbook accounts............. $ 31,259 $ 818 2.62% $ 31,885 $ 846 2.65% $ 31,224 $ 808 2.59%
NOW and money market accounts... 51,447 875 1.70 45,865 759 1.65 39,611 627 1.58
Certificate accounts........... 187,974 10,377 5.52 180,959 10,271 5.68 157,579 7,345 5.19
FHLB advances................... 41,482 2,306 5.56 31,825 1,800 5.66 15,379 8,186 5.81
------- ------- ------- -------- -------- ------ -------- -------- ------
Total interest-bearing
liabilities................ 312,162 14,376 4.61 290,534 13,676 4.71 243,793 10,515 4.31
------- -------- --------
Non-interest-bearing liabilities....3,879 3,198 2,815
------- -------- --------
Total liabilities............ 316,041 293,732 246,608
Stockholders' equity...............50,488 48,896 48,273
------- -------- --------
Total liabilities and
stockholders' equity....... $366,529 $342,628 $294,881
======= ======== ========
Net interest income........................ $ 14,237 $ 13,250 $12,176
======= ======== =======
Interest rate spread....................... 3.70% 3.61% 3.82%
====== ====== ======
Net yield on interest-earning
assets.................................... 4.13% 4.09% 4.36%
====== ====== ======
Ratio of average interest-
earning assets to average
interest-bearing liabilities.............. 110.37% 111.42% 114.49%
======= ====== =======
16
Rate/Volume Analysis
The table below sets forth certain information regarding changes in
interest income and interest expense of the Bank for the periods indicated.
For each category of interest-earning assets and interest-bearing
liabilities, information is provided on changes attributable to (1) changes
in rate (change in rate multiplied by old volume);(2) changes in volume
(change in volume multiplied by old rate); and (3) changes in rate-volume
(change in rate multiplied by change in volume). Changes in rate-volume are
proportionately allocated between rate and volume variance.
Year Ended June 30,
1997 vs. 1996 1996 vs. 1995 1995 vs. 1994
------------------------------ ------------------------------ -------------------------
Increase (Decrease) Increase (Decrease) Increase (Decrease)
Due to Due to Due to
Rate Volume Total Rate Volume Total Rate Volume Total
------ ------ ------- ------ ------ ------- ------ ------ ------
(Dollars in Thousands)
Interest income:
Loans-receivable, net... $ (89) $ 1,860 $ 1,771 $ 578 $ 3,308 $ 3,886 $ (623) $ 2,545 $1,922
Debt securities...............(11) 460 449 (67) 96 29 80 184 264
Equity securities........... (15) 12 (3) 40 12 52 28 100 128
Mortgaged-back
securities................... (7) (39) (46) 18 97 115 0 107 107
FHLB stock.................... 2 12 14 13 24 37 31 17 48
Interest-bearing deposits.....(57) (450) (507) (18) 134 116 185 20 205
------ -------- -------- -------- ------- -------- ------- ------ ------
Total interest-earning
assets................... $ (177) $ 1,855 $ 1,678 $ 564 $ 3,671 $ 4,235 $ (299) $ 2,973 $2,674
====== ======= ======== ======== ======== ======== ======= ======= ======
Interest expense:
Passbook accounts........ $ (9) $ (15) $ (24) $ 20 $ 18 $ 38 $ 17 $ 55 $ 72
Now & money market
accounts.................... 16 100 116 29 103 132 (96) 137 41
Certificate accounts.........(756) (70) (826) 811 1,274 2,085 868 1,317 2,185
FHLB advances................ (32) 538 506 (24) 930 906 12 37 49
------ ------ ------- -------- ------- ------- ------- ------- ------
Total interest-bearing
liabilities.............. $ (781) $ 553 $ (228) $ 836 $ 2,325 $ 3,161 $ 801 $ 1,546 $2,347
====== ======= ======= ======== ======= ======== ======= ======= ======
17
Subsidiary Activities
As a federally-chartered savings bank, the Bank is permitted to invest
an amount equal to 2% of its assets in subsidiaries with an additional
investment of 1% of assets where such investment serves primarily community,
intercity, and community development purposes. Under such limitations, on June
30, 1997, the Bank was authorized to invest up to approximately $11.3 million in
the stock of or loans to subsidiaries. In addition, institutions meeting
regulatory capital requirements, which the Bank does, may invest up to 50% of
their regulatory capital in conforming first mortgage loans to subsidiaries in
which they own 10% or more of the capital stock. As of June 30, 1997, the Bank's
investment in and loans to its subsidiaries was approximately $698,000
consisting of investment in common stock and earnings.
In 1978, the Bank formed First Service Corporation of Elizabethtown
("First Service") which holds an equity interest in Intrieve, Inc.,the company
performing the Bank's data processing. First Service also acts as a broker for
the purpose of selling mortgage life, credit life and accident and disability
insurance to the Bank's customers.
In April, 1988 First Service entered into a contract with Marketing One
Securities, Inc. to provide investment services to the Bank's customers in the
area of tax deferred annuities, government securities and stocks and bonds.
First Service employs three full-time employees to perform these services. This
investment function operates under licenses held by First Service. The net
earnings of First Service was $97,259 during fiscal year 1997.
Savings associations, in determining compliance with capital
requirements, are required to deduct from capital an increasing percentage of
their debt and equity investments in, and extensions of credit to, service
corporations in activities not permissible for a national bank. Certain
activities of the Bank's service corporations are not permissible for national
banks. Accordingly, on June 30, 1997, the Bank deducted 100% of its investment
in its service corporation from its core and tangible capital. See "Regulation
- -- Regulatory Capital Requirements." Because the Bank's investment in its
subsidiary is insignificant, management does not believe that the required
deductions from capital will have a material effect on the Bank's regulatory
capital position.
Competition
First Federal experiences substantial competition both in attracting
and retaining savings deposits and in the making of mortgage and other loans.
Direct competition for savings deposits comes from other savings institutions,
commercial banks, and credit unions located in north-central Kentucky.
Additional significant competition for savings deposits comes from money market
mutual funds and corporate and government debt securities.
The primary factors in competing for loans are interest rates and loan
origination fees and the range of services offered by the various financial
institutions. Competition for origination of real estate loans normally comes
from other savings institutions, commercial banks, mortgage bankers, mortgage
brokers, and insurance companies. First Federal is able to compete effectively
in its primary market area.
First Federal has offices in six cities in four contiguous counties. In
addition to the financial institutions which have offices in these counties,
First Federal competes with several commercial banks and savings institutions in
surrounding counties, many of which have assets which are substantially larger
than First Federal's. In addition, Kentucky's interstate banking statute, which
permits banks in all states to enter the Kentucky market if they have reciprocal
interstate banking statutes, has further increased competition for the Bank.
18
Employees
The Corporation and subsidiaries had 97 full-time employees and 12
part-time employees as of June 30, 1997. None of these employees is represented
by a collective bargaining agreement and the Corporation believes that it enjoys
good relations with its personnel.
Regulation
General. As a federally chartered savings association, First Federal is
subject to extensive regulation by the OTS. The lending activities and other
investments of the Bank must comply with various federal regulatory
requirements. The OTS periodically examines the Bank for compliance with various
regulatory requirements and the FDIC also has the authority to conduct special
examinations of institutions insured by the SAIF. The Bank must file reports
with the OTS describing its activities and financial condition. The Bank is also
subject to certain reserve requirements promulgated by the Board of Governors of
the Federal Reserve System (the "Federal Reserve Board"). This supervision and
regulation is intended primarily for the protection of depositors. As a savings
and loan holding company, the Corporation is subject to the OTS' regulation,
examination, supervision and reporting requirements.
Federal Home Loan Bank System. The Bank is a member of the FHLB System,
which consists of 12 regional Federal Home Loan Banks subject to supervision and
regulation by the Federal Housing Finance Board ("FHLB"). The Federal Home Loan
Banks provide a Central Credit facility primarily for member institutions. As a
member of the FHLB of Cincinnati, the Bank is required to acquire and hold
shares of capital stock in the FHLB of Cincinnati in an amount at least equal to
1% of the aggregate unpaid principal of its home mortgage loans, home purchase
contracts, and similar obligations at the beginning of each year, or 1/20 of its
advances (borrowings) from the FHLB of Cincinnati, whichever is greater. First
Federal was in compliance with this requirement with investment in the FHLB of
Cincinnati stock at June 30, 1997, of $2.8 million.
The FHLB of Cincinnati serves as a reserve or central bank for its
member institutions within its assigned region. It is funded primarily from
proceeds derived from the sale of consolidated obligations of the FHLB System.
It makes advances to members in accordance with policies and procedures
established by the FHFB and the Board of Directors of the FHLB of Cincinnati. As
of June 30, 1997, First Federal had $41.5 million in advances outstanding from
the FHLB of Cincinnati. See "Business - Sources of Funds - Borrowings."
Liquidity Requirements. As a member of the FHLB System, the Bank has
been required to maintain average daily balances of liquid assets (cash,
deposits maintained pursuant to Federal Reserve Board requirements, time and
savings deposits in certain institutions, obligations of states and political
subdivisions thereof, shares in mutual funds with certain restricted investment
policies, highly rated corporate debt, and mortgage loans and mortgage-related
securities with less than one year to maturity or subject to purchase within one
year) equal to the monthly average of not less than a specified percentage of
its net withdrawable savings deposits plus short-term borrowings. This liquidity
requirement, which is currently 5%, may be changed from time to time by the OTS
to any amount within the range of 4% to 10% depending upon economic conditions
and the savings flows of member institutions. Member institutions have also been
required to maintain average daily balances of short-term liquid assets at a
specified percentage (currently 1%) of the total of their net withdrawable
savings accounts and borrowings payable in one year or less. Monetary penalties
may be imposed for failure to meet liquidity requirements. The average liquidity
and short-term liquidity ratios of First Federal for June 1997 were 7.72% and
6.78%, respectively.
19
Qualified Thrift Lender Test. The Bank is currently subject to OTS
regulations which use the concept of a qualified thrift lender ("QTL") to
determine eligibility for Federal Home Loan Bank advances and for certain other
purposes. To qualify as a QTL, a savings association must maintain at least 65%
of its "portfolio" assets in qualified thrift investments. Portfolio assets are
defined as total assets less intangibles, property used by a savings association
in its business and liquidity investments in an amount not exceeding 20% of
assets. Qualified thrift investments consist of: (i) loans, equity positions, or
securities related to domestic, residential real estate or manufactured housing,
credit card and education loans; (ii) property used by the savings association
in the conduct of its business; and (iii) stock in a Federal Home Loan Bank or
the Federal National Mortgage Association or the Federal Home Loan Mortgage
Corporation. Qualified thrift investments may also include liquidity investments
and 50% of the dollar amount of residential mortgage loans subject to sale under
certain conditions. To qualify as a QTL, a savings association must maintain its
status as a QTL on a monthly basis in nine out of every 12 months. Failure to
qualify as a QTL results in a number of sanctions, including the imposition of
certain operating restrictions imposed on national banks and a restriction on
obtaining additional advances from the Federal Home Loan Bank System. Upon
failure to qualify as a QTL for two years, a savings association must convert to
a commercial bank. At June 30, 1997, approximately 97.66% of the Bank's assets
were invested in qualified thrift investments.
Lending Limits. Under regulations of the OTS, loans and extensions of
credit to a person outstanding at one time and not fully secured shall not
exceed 15% of the unimpaired capital, surplus and the loan loss allowance of the
savings association. Loans and extensions of credit fully secured by readily
marketable collateral (as defined) may comprise an additional 10% of unimpaired
capital and surplus. At June 30, 1997, the Bank complied with its regulatory
lending limits.
The aggregate amount of loans which a federally chartered savings
association may make on the security of liens on non-residential real property
may not exceed 400% of the institution's capital, though the Director of OTS has
the authority to permit savings associations to exceed the 400% of capital limit
in certain circumstances.
Regulatory Capital Requirements. OTS regulations require savings
associations to satisfy three different capital requirements. Specifically,
savings associations must maintain "tangible" capital equal to 1.5% of adjusted
total assets, "core" capital equal to 3% of adjusted total assets and a
combination of core and "supplementary" capital equal to 8.0% of "risk-weighted"
assets. OTS regulations impose certain restrictions on savings associations that
have a total risk-based capital ratio that is less than 8.0%, a ratio of Tier 1
capital to risk-weighted assets of less than 4.0% or a ratio of Tier 1 capital
to adjusted total assets of less than 4.0% (or 3.0% if the institution is rated
composite 1 under the OTS examination rating system). For purposes of these
regulations, Tier 1 capital has the same definitions as core capital. See "--
Prompt Corrective Regulatory Action."
For purposes of the OTS's regulatory capital regulations, core capital
is defined as common stockholders' equity (including retained earnings),
noncumulative perpetual preferred stock and related surplus, minority interests
in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Core capital is generally reduced by the amount of the savings
association's intangible assets for which no market exists. Limited exceptions
to the deduction of intangible assets are provided for purchased mortgage
servicing rights and qualifying supervisory goodwill held by an eligible savings
associating. Tangible capital is given the same definition as core capital but
does not include qualifying supervisory goodwill and is reduced by the amount of
all the savings association's
20
intangible assets with only a limited exception for purchased mortgage servicing
rights.
Adjusted total assets are a savings association's total assets as
determined under generally accepted accounting principles, adjusted for certain
goodwill amounts, and increased by a pro rata portion of the assets of
subsidiaries in which the savings association holds a minority interest and
which are not engaged in activities for which the capital rules require the
savings association to net its debt and equity investments against capital, as
well as a pro rata portion of the assets of other subsidiaries for which netting
is not fully required under the phase-in rules. Adjusted total assets are
reduced by the amount of assets that have been deducted from capital, the
portion of savings association's investments in subsidiaries that must be netted
against capital under the capital rules and, for purposes of the core capital
requirement, qualifying supervisory goodwill.
In determining compliance with the risk-based capital requirement, a
savings association is allowed to use both core capital and supplementary
capital provided the amount of supplementary capital used does not exceed the
savings association's core capital. Supplementary capital is defined to include
certain preferred stock issues, nonwithdrawable accounts and pledged deposits
that do not qualify as core capital, certain approved subordinated debt, certain
other capital instruments and a portion of the savings association's general
loss allowances. Total core and supplementary capital are reduced by an amount
equal to the savings association's high loan-to-value ratio land loans and
non-residential construction loans and the amount of capital instruments held by
other depository institutions pursuant to reciprocal arrangements as well as by
an increasing percentage of the savings association's equity investments.
The risk-based capital requirement is measured against risk-weighted
assets which equals the sum of each asset and the credit-equivalent amount of
each off- balance sheet item after being multiplied by an assigned risk weight.
Under the OTS risk-weighted system, one-to four-family first mortgages not more
than 90 days past due with loan-to-value ratios under 80% are assigned a risk
weight of 50%. Consumer loans are assigned a risk weight of 100%.
Mortgage-backed securities issued, or fully guaranteed as to principal and
interest, by the FNMA or FHLMC are assigned a 20% risk weight. Cash and U.S.
Government securities backed by the full faith and credit of the U.S. Government
are given a 0% risk weight. The risk-based capital requirement is 8% of
risk-weighted assets.
In determining compliance with capital standards, all of a savings
association's investments in, and extensions of credit to, any subsidiary
engaged in activities not permissible for a national bank are also to be
deducted from the savings association's capital. Certain subsidiaries are
exempted from this treatment, including any subsidiary engaged in impermissible
activities solely as agent for its customers (unless the FDIC determined
otherwise), subsidiaries engaged solely in mortgage banking, and depository
institution subsidiaries acquired prior to May 1, 1989. In addition, the capital
deduction is not applied to federal savings associations existing as of August
9, 1989 that were either chartered as a state savings bank or state cooperative
bank prior to October 10, 1982 or that acquired their principal assets from such
an association. The required reduction of capital for this purpose is being
phased in over a period of approximately five years. At June 30, 1997, the
Bank's investment in First Service, a wholly owned subsidiary of the Bank
engaged in activities which are not permitted for a national bank, amounted to
$698,000. Accordingly, on June 30, 1997, the Bank deducted 100% of this
investment from its core and tangible capital.
21
The tables below present the Bank's capital position relative to its
various minimum regulatory capital requirements at June 30, 1997.
June 30, 1997
Percent of
Amount Assets (1)
(Dollars in thousands)
Tangible capital.............................. $ 45,817 12.3%
Tangible capital requirement.................. 5,599 1.5
-------- ----
Excess........................................ $ 40,218 10.8%
======== ====
Tier 1/Core capital........................... $ 45,817 12.3%
Tier 1/Core capital
requirement.................................. 11,197 3.0
-------- ----
Excess........................................ $ 34,620 9.3%
======== ====
Tier 1/Risk-based capital..................... $ 45,817 18.9%
Tier 1/Risk-based capital
requirement.................................. 9,712 4.0
-------- ----
Excess....................................... $ 36,105 14.9%
======== ====
Risk-based capital............................ $ 47,532 19.6%
Risk-based capital
requirement.................................. 19,423 8.0
-------- ----
Excess........................................ $ 28,109 11.6%
======== ====
(1) Based upon adjusted total assets for purposes of the tangible capital
and core capital requirements, and risk-weighted assets for purposes of
the risk-based capital requirements.
The OTS risk-based capital requirements require savings institutions with
more than a "normal" level of interest rate risk to maintain additional total
capital. A savings institution's interest rate risk is measured in terms of the
sensitivity of its "net portfolio value" to changes in interest rates. Net
portfolio value is defined, generally, as the present value of expected cash
inflows from existing assets and off-balance sheet contracts less the present
value of expected cash outflows from existing liabilities. A savings institution
is considered to have a "normal" level of interest rate risk exposure if the
decline in its net portfolio value after an immediate 200 basis point increase
or decrease in market interest rates (whichever results in the greater decline)
is less than two percent of the current estimated economic value of its assets.
A savings institution with a greater than normal interest rate risk is required
to deduct from total capital, for purposes of calculating its risk-based capital
requirement, an amount (the "interest rate risk component") equal to one-half
the difference between the institution's measured interest rate risk and the
normal level of interest rate risk, multiplied by the economic value of its
total assets.
The OTS will calculate the sensitivity of a savings institution's net
portfolio value based on data submitted by the institution in a schedule to its
quarterly Thrift Financial Report and using the interest rate risk measurement
model adopted by the OTS. The amount of the interest rate risk component, if
any, for any quarter is based on the institution's Thrift Financial Report filed
three
22
quarters earlier. The Bank does not have more than a normal level of interest
rate risk under the new rule and is not required to increase its total capital
as a result of the rule.
While the Bank complies with its currently applicable capital
requirements and expects to continue to comply with the requirements, any
failure to comply with the capital requirements in the future would result in
severe penalties. In addition to requiring generally applicable capital
standards for savings associations, applicable regulations authorize the
Director of OTS to establish the minimum level of capital for a savings
institution at such amount or at such ratio of capital-to-assets as the Director
determines to be necessary or appropriate for such institution in light of the
particular circumstances of the institution. The Director of OTS may treat the
failure of any savings institution to maintain capital at or above such level as
an unsafe or unsound practice and may issue a directive requiring any savings
institution which fails to maintain capital at or above the minimum level
required by the Director to submit and adhere to a plan for increasing capital.
Such an order may be enforced in the same manner as an order issued by the FDIC.
The OTS staff policies specify that savings institutions failing any
one of their minimum regulatory capital requirements may not increase their
total assets during any quarter in excess of an amount equal to net interest
credited during the quarter. Under these policies, institutions that have
submitted capital plans that are rejected by the District Director or that have
had capital plans approved but do not meet the targets or requirements of the
capital plan may not make any new loans or investments except with the prior
written approval of the District Director. Such approval will only be granted
when the proposed loan or investment is reasonable in the context of the
institution's operations and does not significantly increase the risk profile of
the savings institution.
The Director of OTS must restrict the asset growth of savings
associations not in regulatory capital compliance, subject to a limited
exception for growth not exceeding interest credited. In addition, savings
associations not in full compliance with applicable capital standards are
subject to a capital directive which may include such restrictions, including
restrictions on the payment of dividends and on compensation, as deemed
appropriate by the Director of OTS. The Director of OTS is directed to treat as
an unsafe and unsound practice any material failure by a savings association to
comply with a capital plan or capital directive. The sanctions and penalties
that could be imposed range from restrictions on branching or on the activities
of the institution, to restrictions on the ability to obtain FHLB advances, to
termination of insurance of accounts following appropriate proceedings, to the
appointment of a conservator or receiver.
Prompt Corrective Regulatory Action
Under the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), the federal banking regulators are required to take prompt
corrective action if an insured depository institution fails to satisfy certain
minimum capital requirements. All institutions, regardless of their capital
levels, are restricted from making any capital distribution or paying any
management fees if the institution would thereafter fail to satisfy the minimum
levels for any of its capital requirements. An institution that fails to meet
the minimum level for any relevant capital measure (an "undercapitalized
institution") may be: (i) subject to increased monitoring by the appropriate
federal banking regulator; (ii) required to submit an acceptable capital
restoration plan within 45 days; (iii) subject to asset growth limits; and (iv)
required to obtain prior regulatory approval for acquisitions, branching and new
lines of businesses. The capital restoration plan must include a guarantee by
the institution's holding company
23
that the institution will comply with the plan until it has been adequately
capitalized on average for four consecutive quarters, under which the holding
company would be liable up to the lesser of 5% of the institution's total assets
or the amount necessary to bring the institution into capital compliance as of
the date it failed to comply with its capital restoration plan. A "significantly
undercapitalized" institution, as well as any undercapitalized institution that
did not submit an acceptable capital restoration plan, may be subject to
regulatory demands for recapitalization, broader application of restrictions on
transactions with affiliates, limitations on interest rates paid on deposits,
asset growth and other activities, possible replacement of directors and
officers, and restrictions on capital distributions by any bank holding company
controlling the institution. Any company controlling the institution could also
be required to divest the institution or the institution could also be required
to divest subsidiaries. The senior executive officers of a significantly
undercapitalized institution may not receive bonuses or increases in
compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt. In their
discretion, the federal banking regulators may also impose the foregoing
sanctions on an undercapitalized institution if the regulators determine that
such actions are necessary to carry out the purposes of the prompt corrective
action provisions. If an institution's ratio of tangible capital to total assets
falls below a "critical capital level," the institution will be subject to
conservatorship or receivership within 90 days unless periodic determinations
are made that forbearance from such action would better protect the deposit
insurance fund. Unless appropriate findings and certifications are made by the
appropriate federal bank regulatory agencies, a critically undercapitalized
institution must be placed in receivership if it remains critically
undercapitalized on average during the calendar quarter beginning 270 days after
the date it became critically undercapitalized. If a savings association is in
compliance with an approved capital plan on the date of enactment of FDICIA,
however, it will not be required to submit a capital restoration plan if it is
undercapitalized or become subject to the statutory prompt corrective action
provisions applicable to significantly and critically undercapitalized
institutions prior to July 1, 1995.
Under FDICIA, regulations implementing the prompt corrective action
provisions of a depository institution's capital adequacy is measured on the
basis of the institution's total risk-based capital ratio (the ratio of its
total capital to risk-weighted assets), Tier 1 risk-based capital ratio (the
ratio of its core capital to risk-weighted assets) and leverage ratio (the ratio
of its core capital to adjusted total assets). Under the regulations, a savings
association that is not subject to an order or written directive to meet or
maintain a specific capital level will be deemed "well capitalized" if it also
has: (i) a total risk-based capital ratio of 10% or greater; (ii) a Tier 1
risk-based capital ratio of 6.0% or greater; and (iii) a leverage ratio of 5.0%
or greater. An "adequately capitalized" savings association is a savings
association that does not meet the definition of well capitalized and has: (i) a
total risk-based capital ratio of 8.0% or greater; (ii) a Tier 1 capital
risk-based ratio of 4.0% or greater; and (iii) a leverage ratio of 4.0% or
greater (or 3.0% or greater if the savings association has a composite of 1
MACRO rating). An "undercapitalized institution" is a savings association that
has (i) a total risk-based capital ratio less than 8.0%; or (ii) a Tier 1
risk-based capital ratio of less than 4.0%; or (iii) a leverage ratio of less
than 4.0% (or 3.0% if the association has a composite 1 MACRO rating). A
"significantly undercapitalized" institution is defined as a savings association
that has: (i) a total risk-based capital ratio of less than 6.0%; or (ii) a Tier
1 risk-based capital ratio of less than 3.0%; or (iii) a leverage ratio of less
than 3.0%. A "critically undercapitalized" savings association defined as a
savings association that has a ratio of core capital to total assets of less
than 2.0%. The OTS may reclassify a well capitalized savings association as
adequately capitalized and may require an adequately capitalized or
undercapitalized
24
association to comply with the supervisory actions applicable to associations in
the next lower opportunity for a hearing, that the savings association is in an
unsafe or unsound condition or that the association has received and not
corrected a less-than-satisfactory rating for any MACRO rating category. First
Federal is classified as "well capitalized" under the new regulations.
Deposit Insurance
Under FDICIA, the FDIC has established a risk-based assessment system for
insured depository institutions. Under the system, the assessment rate for an
insured depository institution depends on the assessment risk classification
assigned to the institution by the FDIC which will be determined by the
institution's capital level and supervisory evaluations. Institutions are
assigned to one of three capital groups -- well capitalized, adequately
capitalized or undercapitalized -- based on the data reported to regulators for
date closest to the last day of the seventh month preceding the semi-annual
assessment period. Well capitalized institutions are institutions satisfying the
following capital ratio standards; (i) total risk-based capital ratio of 10.0%
or greater; (ii) Tier 1 risk-based capital ratio of 6.0% or greater; and (iii)
Tier 1 leverage ratio of 5.0% or greater. Adequately capitalized institutions
are institutions that do not meet the standards for well capitalized
institutions but which satisfy the following capital ratio standards: (i) total
risk-based capital ratio of 8.0% or greater; (ii) Tier 1 risk-based capital
ratio of 4.0% or greater; and (iii) Tier 1 leverage ratio of 4.0% or greater.
Undercapitalized institutions consist of institutions that do not qualify as
either "well capitalized" or "adequately capitalized." Within each capital
group, institutions are assigned to one of the three subgroups on the basis of
supervisory evaluations by the institution's primary supervisory authority and
such other information as the FDIC determines to be relevant to the institutions
financial condition and the risk posed to the deposit insurance fund. Subgroup A
consists of financially sound institution's with only a few minor weaknesses.
Subgroup B consists of institutions that demonstrate weaknesses which, if not
corrected, could result in significant deterioration of the fund. Subgroup C
consists of institutions that pose a substantial probability of loss to the
deposit insurance fund unless effective corrective action is taken. Under
FDICIA, the FDIC has established a risk-based assessment system for insured
depository institutions. Under the system, the assessment rate for an insured
depository institution depends on the assessment risk classification assigned to
the institution by the FDIC which will be determined by the institution's
capital level and supervisory evaluations. Institutions are assigned to one of
three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- based on the data reported to regulators for date closest to
the last day of the seventh month preceding the semi-annual assessment period.
Well capitalized institutions are institutions satisfying the following capital
ratio standards; (i) total risk-based capital ratio of 10.0% or greater; (ii)
Tier 1 risk-based capital ratio of 6.0% or greater; and (iii) Tier 1 leverage
ratio of 5.0% or greater. Adequately capitalized institutions are institutions
that do not meet the standards for well capitalized institutions but which
satisfy the following capital ratio standards: (i) total risk-based capital
ratio of 8.0% or greater; (ii) Tier 1 risk-based capital ratio of 4.0% or
greater; and (iii) Tier 1 leverage ratio of 4.0% or greater. Undercapitalized
institutions consist of institutions that do not qualify as either "well
capitalized" or "adequately capitalized." Within each capital group,
institutions are assigned to one of the three subgroups on the basis of
supervisory evaluations by the institution's primary supervisory authority and
such other information as the FDIC determines to be relevant to the institutions
financial condition and the risk posed to the deposit insurance fund. Subgroup A
consists of financially sound institution's with only a few minor weaknesses.
Subgroup B consists of institutions that demonstrate weaknesses which, if not
corrected, could result in significant deterioration of the fund. Subgroup C
consists of institutions that pose a substantial probability of loss to the
deposit insurance fund unless effective corrective action is taken.
The Bank insures its customers' deposits through the Savings Association
Insurance Fund ("SAIF"). On September 30, 1996, Federal Deposit Insurance
Corporation ("FDIC") legislation was signed into law to recapitalize the SAIF
due to a substantial disparity that existed between the premiums assessed by the
SAIF as compared to premiums assessed to commercial banks. All SAIF-insured
savings institutions were required to pay a one-time special assessment of $.657
for every $100 of customer deposits held as of March 31, 1995. This has resulted
in a charge to earnings of $1,095,000, net of tax, during the first quarter of
fiscal 1997. On January 1, 1997, the Bank began paying insurance premiums of
$.064 per $100 of deposits as compared to a previous premium of $.23 per $100 of
deposits. The reduced premium contributed approximately $143,000, net of tax, to
1997 earnings.
Federal Reserve System
Pursuant to regulations of the Federal Reserve Board, a thrift
institution must maintain average daily reserves equal to 3% on the first $51.9
million of transaction accounts, plus 10% on the remainder. This percentage is
subject to adjustment by the Federal Reserve Board. Because required reserves
must be maintained in the form of vault cash or in a non-interest bearing
account at a Federal Reserve Bank, the effect of the reserve requirement is to
reduce the amount of the institution's interest-earning assets. As of June 30,
1997, the Bank met its reserve requirements.
25
Savings and Loan Holding Company Regulations. The Corporation is a
savings and loan holding company within the meaning of the Home Owners' Loan
Act, as amended. As such, it is registered with the OTS and is subject to OTS
regulations, examinations, supervision and reporting requirements. As a
subsidiary of a savings and loan holding company, First Federal is subject to
certain restrictions in its dealings with the Corporation and affiliates
thereof.
The Home Owners' Loan Act, as amended, generally prohibits a savings
and loan holding company, without prior approval of the Director of OTS, from
(i) acquiring control of any other savings institution or savings and loan
holding company or controlling the assets thereof or (ii) acquiring or retaining
more than 5% of the voting shares of a savings institution or holding company
thereof which is not a subsidiary. Additionally, under certain circumstances, a
savings and loan holding company is permitted to acquire, with the approval of
the Director of OTS, up to 15% of previously unissued voting shares of an
under-capitalized savings association for cash without that savings association
being deemed controlled by the holding company. Except with the prior approval
of the Director of OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock may also acquire control of any savings institution, other
than a subsidiary institution or any other savings and loan holding company.
The Bank Holding Company Act of 1956 specifically authorizes the
Federal Reserve Board and the Director of the OTS to approve an application by a
bank holding company to acquire control of any savings institution. Pursuant to
rules promulgated by the Federal Reserve Board, owning, controlling or operating
a savings institution is a permissible activity for bank holding companies, if
the savings institution engages only in deposit-taking activities and lending
and other activities that are permissible for the bank holding companies. In
approving such as application, the Federal Reserve Board may not impose any
restriction on transaction between the savings institution and its holding
company affiliates except as required by Sections 23A and 23B of the Federal
Reserve Act.
A bank holding company that controls a savings institution may merge or
consolidate the assets and liabilities of the savings institution with, or
transfer assets and liabilities to, any subsidiary bank which is a member of the
BIF with the approval of the appropriate federal banking agency and the Federal
Reserve Board. The resulting bank will be required to continue to pay
assessments to the SAIF at the rates prescribed for SAIF members on the deposits
attributable to the merged savings institution plus an annual growth increment.
Transactions between savings associations and any affiliate are
governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a
savings association is any company or entity which controls, is controlled by or
is under common control with the savings association. In a holding company
context, the parent holding company of a savings association (such as the
Corporation) and any companies which are controlled by such parent holding
company are affiliates of the savings association. Generally, Sections 23A and
23B (i) limit the extent to which the savings institution or its subsidiaries
may engage in "covered transactions" with any one affiliate to an amount equal
to 10% of such institution's capital stock and surplus, and contain an aggregate
limit on all such transactions with all affiliates to an amount equal to 20% of
such capital stock and surplus and (ii) require that all such transactions be on
terms substantially the same, or at least as favorable, to the institution or
subsidiary as those provided to a non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
similar other types of transactions. Additionally, in addition to the
restrictions imposed by Sections 23A and 23B, no savings association may (i)
loan or otherwise extend credit to an affiliate, except for any affiliate which
engages only in activities which are permissible for bank holding companies, or
(ii) purchase or invest in any stocks, bonds, debentures, notes or similar
obligations of any affiliate,
26
except for affiliates which are subsidiaries of the savings association.
Savings associations are also subject to the restrictions contained in
Section 22 (h) of the Federal Reserve Act on loans to executive officers,
directors and principal shareholders. Under Section 22 (h), loans to an
executive officer and to a greater than 10% shareholder of a savings association
(18% in the case of institutions located in an area with less than 30,000 in
population), and certain affiliated entities of either, may not exceed together
with all other outstanding loans to such person and affiliated entities the
association's loan to one borrower limit as established by FIRREA (generally
equal to 15% of the institution's unimpaired capital and surplus, for loans
fully secured by certain readily marketable collateral, an additional 10% of the
institution's unimpaired capital and surplus). Section 22(h) also prohibits
loans, above amounts prescribed by the appropriate federal banking agency, to
directors, executive officers and greater than 10% shareholders of savings
association, and their respective affiliates, unless such loan is approved in
advance by a majority of the board of directors of the association with any
"interested" director not participating in the voting. The Federal Reserve Board
has prescribed the loan amount (which includes all other outstanding loans to
such person), as to which such prior board of director approval if required, as
being the greater of $25,000 or 5% of capital and surplus (up to $500,000).
Further, the Federal Reserve Board pursuant to Section 22(h) requires that loans
to directors, executive officers and principal shareholders be made on terms
substantially the same as offered in comparable transactions to other persons.
The Board of Directors of the Corporation presently intends to operate
the Corporation as a unitary savings and loan holding company. There are
generally no restrictions on the activities of a unitary savings and loan
company. However, if the director of OTS determines that there is reasonable
cause to believe that the continuation by a savings and loan holding company of
an activity constitutes a serious risk to the financial safety, soundness or
stability of its subsidiary savings association, the Director of OTS may impose
such restrictions as deemed necessary to address such risk and limiting (i)
payment of dividends by the savings association, (ii) transactions between the
savings association and its affiliates, and (iii) any activities of the savings
association that might create a serious risk that the liabilities of the holding
company and its affiliates may be imposed on the savings association.
Notwithstanding the above rules as to permissible business activities
of unitary savings and loan holding companies, if the savings association
subsidiary of such a holding company fails to meet (in three out to every four
quarters and two out of every three years) the QTL test, see "Qualified Thrift
Lender Test" above, then such unitary holding company shall also become subject
to the activities restrictions applicable to multiple holding companies
(additional restrictions on securing advances from the FHLB also apply).
If the Corporation were to acquire control of another savings
institution other than through merger or other business combinations with First
Federal, the Corporation would thereupon become a multiple savings and loan
holding company. Except where such acquisition is pursuant to the authority to
approve emergency thrift acquisitions and where each subsidiary savings
institution meets the QTL test, the activities of the Corporation and any of its
subsidiaries (other than First Federal or other subsidiary savings institutions)
would thereafter be subject to further restrictions. The Home Owners' Loan Act,
as amended, provides that, among other things, no multiple savings and loan
holding company or subsidiary thereof which is not a savings institution shall
commence or continue for more than a limited period of time after becoming a
multiple savings and loan holding company or subsidiary thereof, any business
activity other than (i) furnishing or performing management services for a
subsidiary savings institution, (ii) conducting an insurance agency or escrow
business, (iii) holding, managing, or liquidating assets owned by or acquired
from a subsidiary savings institution,
27
(iv) holding or managing properties used or occupied by a subsidiary savings
institution, (v) acting as trustee under deeds of trust, (vi) those activities
previously directly authorized by the FSLIC by regulations as of March 5, 1987
to be engaged in by multiple holding companies or (vii) those activities
authorized by the Federal Reserve Board as permissible for bank holding
companies, unless the Director of OTS by regulation prohibits or limits such
activities for savings and loan holding companies. Those activities described in
(vii) above must also be approved by the Director of OTS prior to being engaged
in by a multiple holding company.
The Director of OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state, if the multiple savings and loan holding
company involved controls a savings institution which operated a home or branch
office in the state of the institution to be acquired as of March 5, 1987, or if
the laws of the state in which the institution to be acquired is located
specifically permit institution to be acquired by state-chartered institutions
or savings and loan holding companies located in the state where the acquiring
entity is located (or by a holding company that controls such state-chartered
savings institutions). The Director of OTS may approve an acquisition resulting
in a multiple savings and loan holding company controlling savings institutions
in more than one state in the case of certain emergency thrift acquisitions.
No subsidiary savings association of a savings and loan holding company
may declare or pay a dividend on its permanent or nonwithdrawable stock unless
it first gives the Director of OTS 30 day advance notice of such declaration and
payment. Any dividend declared during such period or without the giving of such
notice shall be invalid.
Federal and State Taxation
The Corporation and the Bank currently file consolidated federal income
tax returns based on a fiscal year ending June 30.
The Small Business Job Protection Act passed by Congress in August 1996
included a provision that repealed the percentage of taxable income bad debt
deduction for federal income tax purposes. The Bank used this method to
determine its bad debt deduction when computing federal taxes in applicable
years. This new legislation also requires recapture of the excess of bad debt
reserves over the base year reserve as of December 31, 1987. For years
subsequent to the base year, deferred taxes have been recorded; thus, no
additional tax provision is required as a result of this legislation. Under the
new legislation, the Bank is required to use the specific charge-off method to
calculate the bad debt deduction for federal income tax purposes. The new
legislation is effective for tax years beginning after December 31, 1995.
Earnings appropriated to the Bank's bad debt reserve and claimed as a
tax deduction will not be allowable for the payment of cash dividends or for
distribution to shareholders (including distributions made on dissolution or
liquidation), without payment of federal income taxes on such dividends or
distributions by the Bank at the then current tax rates on the amount deemed
removed to the Bank would include not only the amount actually distributed, but
would also be increased (subject to certain limitations) by the amount of the
tax payable by reason of such distribution.
The Corporation adopted Statement of Financial Accounting Standard No. 109
(SFAS No. 109), "Accounting for Income Taxes," on July 1, 1993.
SFAS No. 109 calculates taxes on the liability method, thus requiring the
recognition of current and deferred tax liabilities and assets for the expected
28
future tax consequences of events that have been recognized in the financial
statements or tax return. This statement's emphasis on the balance sheet is
consistent with SFAS No. 96 but is a change from APB No. 11's emphasis on the
expense calculation. Under SFAS No. 109, the tax expense or benefit in the
statement of operations will be the current tax liability plus the change in the
deferred tax liabilities and assets occurring during the year. SFAS No. 109
changes the treatment of loan loss provisions in the calculation of taxes. Tax
bad debt reserves that arose prior to 1988 will require recognition of deferred
tax liabilities only if it becomes apparent that those temporary differences
will reverse in the foreseeable future. Other differences between financial and
tax reserves will create temporary differences for which deferred tax assets or
liabilities will be computed.
The Commonwealth of Kentucky imposes no income tax on savings
institutions. Nonetheless, First Federal must pay a Kentucky ad valorem tax.
This tax is 1/10th of 1% of First Federal's total savings accounts, common
stock, capital and retained income with certain deductions for amounts borrowed
by depositors and for securities guaranteed by the U.S. Government or certain of
its agencies. The Bank's subsidiary must pay a state income tax, as well as a
tax on capital. The tax on income is 4% for the first $25,000 of taxable income,
5% for the next $25,000, 6% for the next $50,000, 7% for the next $150,000 and
8.25% for all income over $250,000. The tax on capital is .0021 times the
capital employed with a credit of .0014 times the first $350,000 of capital for
those corporations with gross income of under $500,000.
For information regarding federal income taxes, see Note 8 of the Notes
to Consolidated Financial Statements in the Annual Report.
29
Item 2. Properties
The following table sets forth the location of the Bank's offices, as well
as certain additional information relating to these offices at June 30, 1997.
All of the properties are owned by the Bank.
Year Approximate
Facility Square
Office Location Opened Net Book Value Footage
(Dollars in thousands)
Home Office 1993 $6,314 55,000
2323 Ring Road
Elizabethtown, Kentucky
Radcliff Office 1975 575 2,728
475 West Lincoln Trail
Radcliff, Kentucky
Bardstown Office (1) 1973 659 1,271
315 North Third Street
Bardstown, Kentucky
Munfordville Office 1976 263 2,928
925 Main Street
Munfordville, Kentucky
Elizabethtown Office 1985 292 1,764
325 West Dixie Avenue
Elizabethtown, Kentucky
Shepherdsville Office 1995 1,156 7,600
395 North Buckman Street
Shepherdsville, Kentucky
Mt. Washington Office 1995 613 2,500
279 Bardstown Road
Mt. Washington, Kentucky
Wal-Mart Office 1996 341 984
101 Wal-Mart Drive
Elizabethtown, Kentucky
(1) On August 1, 1996, the Bank leased land under a five-year operating lease
agreement for $2,350 per month. This lease contains options to renew the terms
of the lease for an additional forty-five years. The land lease is to be the
site of a new Bardstown branch location which is currently under construction.
Total construction costs are estimated to be approximately $1.1 million of which
$550,000 has been funded through June 30, 1997.
As of June 30, 1997, the net book value of office properties and
equipment owned by the Bank and its subsidiaries was $10.2 million. For further
information, see Note 5 of the Notes to Consolidated Financial Statements in the
Annual Report.