Kentucky First Federal Bancorp - Quarter Report: 2005 December (Form 10-Q)

Kentucky First Federal Bancorp

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

Forward-Looking Statements

Certain statements contained in this report that are not historical facts are forward-looking statements that are subject to certain risks and uncertainties.  When used herein, the terms “anticipates,” “plans,” “expects,” “believes,” and similar expressions as they relate to Kentucky First Federal Bancorp or its management are intended to identify such forward looking statements.  Kentucky First Federal Bancorp’s actual results, performance or achievements may materially differ from those expressed or implied in the forward-looking statements.  Risks and uncertainties that could cause or contribute to such material differences include, but are not limited to, general economic conditions, prices for real estate in the Company’s market areas, interest rate environment, competitive conditions in the financial services industry, changes in law, governmental policies and regulations, and rapidly changing technology affecting financial services.

Discussion of Financial Condition Changes from June 30, 2005 to December 31, 2005

Assets:  At December 31, 2005, the Company’s assets totaled $263.7 million, a decrease of $10.2 million, or 3.7%, from total assets at June 30, 2005.  The primary reason for the decrease in assets was a reduction of $5.2 million, or 62.0%, in cash and cash equivalents, which declined to $3.2 million at December 31, 2005.  Investment securities classified as held to maturity, which decreased $4.0 million or 7.8% to $46.9 million at December 31, 2005, also contributed to the reduction in total assets.  To the extent possible, the Company has sought to redeploy liquidity into mortgage loans. 

Cash and cash equivalents:  Cash and cash equivalents decreased by $5.2 million or 62.0%.  It is the Company’s preference to minimize the level of cash and cash equivalents and invest liquidity into higher-yielding assets, when possible.  The decrease is a part of the overall decrease in assets, discussed more fully under “Investment Securities” and “Liabilities.”

Loans:  Loans receivable, net, increased to $153.7 million at December 31, 2005, an increase of $2.0 million or 1.3%.  Management believes that the successful redeployment of the Company’s funds from lower-yielding cash, cash equivalents and investment securities to higher-yielding mortgage loans is important for the long-term success of the Company.  The Company will continue to emphasize loan originations to the extent it is profitable and prudent.

Investment and Mortgage-Backed Securities:  At December 31, 2005, the Company’s investment securities had decreased $6.6 million or 7.7% to $80.2 million.  This decrease was in part due to redeployment of investments and mortgage-backed security proceeds into loans, but was primarily attributable to the tandem decrease in deposits.  Given recent increases in market interest rates, the Company at times has not met market rates if the resulting deposits cannot be invested profitably in interest-earning assets.  As a result, the level of investment and mortgage-backed securities has decreased.

Non-Performing Assets: At December 31, 2005, the Company had approximately $1.3 million (0.9% of net loans) in loans 90 days or more past due, as compared to $1.7 million at June 30, 2005.  At December 31, 2005, the Company’s allowance for loan losses of $733,000 represented 56.2% of nonperforming loans and 0.5% of total loans.

The Company had $984,000 in loans classified as substandard for regulatory purposes at December 31, 2005. On a percentage basis, classified loans dropped from 1.3% at June 30, 2005 to 1.0%  of total loans at December 31, 2005.  Substandard assets included 33 single-family home loans with loan-to-value ratios (percentage of loan balance to the original or an updated appraisal) ranging from 5% to 86%; plus one home equity line of credit secured by a single-family home which, combined with the first mortgage (which was not delinquent) had a total loan-to-value ratio of 86%.  There was no real estate acquired through foreclosure at December 31, 2005.

At December 31, 2005, no loans were classified as doubtful or loss for regulatory purposes.

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Kentucky First Federal Bancorp

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

Discussion of Financial Condition Changes from June 30, 2005 to December 31, 2005 (continued)

Liabilities:  At December 31, 2005, the Company’s liabilities totaled $198.4 million, a decrease of $9.6 million, or 4.6%, from total liabilities at June 30, 2005.  The decrease in liabilities was attributed primarily to an $8.1 million or 5.2% decrease in deposits, which declined to $146.9 million at December 31, 2005.  As discussed, deposits have decreased as a result of recent increases in market interest rates.  The Company at times has not met market rates if the resulting deposits cannot be invested profitably in interest-earning assets. 

Shareholders’ Equity:  At December 31, 2005, the Company’s shareholders’ equity totaled $65.4 million, a decrease of $584,000 or 0.9% from the June 30, 2005 level.  The primary reason for the decrease in shareholders’ equity is the acquisition of $831,000 worth of shares to fulfill the obligations of the Company’s Equity Incentive Plan, which was approved at the Company’s Annual Meeting held November 15, 2005.

Comparison of Operating Results for the Six-Month Periods Ended December 31, 2005 and 2004

General

Net earnings totaled $940,000 for the six months ended December 31, 2005, an increase of $292,000, or 45.1% from the $648,000 in net earnings for the same period in 2004.  The increase was primarily attributable to a $1.6 million  increase in net interest income, coupled with an increase of $111,000 in other income, partially offset by an increase of $1.3 million in general, administrative and other expense and an increase of $100,000 in the provision for federal income taxes.  The period to period increase in operating levels of income and expense are primarily attributable to the acquisition of Frankfort First.

Net Interest Income

Interest income on loans increased by $3.4 million, or 288.1%, for the six months ended December 31, 2005, compared to the 2004 period.  This increase was due primarily to a $119.2 million, or 365.4%, increase in the average loan portfolio balance outstanding period to period offset by a 120 basis point decrease in the weighted-average yield, to 6.03% for the 2005 six-month period.  The $119.5 million loan portfolio acquired in the acquisition of Frankfort First was significantly larger than First Federal of Hazard’s portfolio.  Income on other interest-earning assets increased by $115,000, or 6.8%, due primarily to a 188 basis point increase in the weighted-average yield, to 3.77% for the 2005 period, which more than offset a $5.1 million, or 5.1%, decrease in the average balance of the related assets outstanding period to period.  As set forth above, interest income was favorably influenced in the 2005 period by the addition of $114.1 million of interest-earning assets, of which approximately $122.0 million were acquired in the Frankfort First transaction.

Interest expense on deposits increased by $1.0 million, or 107.1%, for the six months ended December 31, 2005, compared to the same period in 2004.  This increase was due primarily to a $55.1 million, or 55.7%, increase in the average balance of deposits outstanding period to period, generally reflecting the assumption of $72.5 million of average deposits in the Frankfort First combination.  The weighted average cost of deposits was 2.53% for the 2005 period and 1.91% for the 2004 period.  Interest expense on borrowings increased by $948,000, or 707.5%, due primarily to the assumption of $42.9 million of average FHLB advances in the Frankfort First combination.  The weighted average cost of borrowings increased 129 basis points to 4.27% for the 2005 period.

As a result of the foregoing changes in interest income and interest expense, net interest income increased by $1.6 million, or 86.3%, to a total of $3.4 million for the six months ended December 31, 2005.  Net interest margin increased by 2 basis points to 2.71% for the six months ended December 31, 2005, compared to the prior year period.

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Kentucky First Federal Bancorp

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

Comparison of Operating Results for the Six-Month Periods Ended December 31, 2005 and 2004 (continued)

Provision for Losses on Loans

The Company charges a provision for losses on loans to earnings to bring the total allowance for loan losses to a level considered appropriate by management based on historical experience, the volume and type of lending conducted by the Banks, the status of past due principal and interest payments, general economic conditions, particularly as such conditions relate to the Banks’ market areas, and other factors related to the collectibility of the Banks’ loan portfolio. The Company recorded a provision for losses on loans totaling $24,000 during the six months ended December 31, 2005, a decrease of $4,000, or 14.3%, from the comparable six-month period in 2004.  There can be no assurance that the loan loss allowance will be adequate to absorb losses on known nonperforming loans or that the allowance will be adequate to cover losses on nonperforming assets in the future, which could adversely affect the Company’s results of operations.

Other Income

Other income totaled $122,000 for the six months ended December 31, 2005, an increase of $111,000 from the same period in 2004.  The increase in the 2005 period is attributable, among other things, to $40,000 of earnings on bank-owned life insurance and $23,000 in gain on sale of loans.  These activities were not present before the acquisition of Frankfort First.

General, Administrative and Other Expense

General, administrative and other expense totaled $2.1 million for the six months ended December 31, 2005, an increase of $1.3 million, or 159.1%, compared to the same period in 2004.  This increase was due primarily to effects of the Frankfort First combination and the costs of operating a public company.  Employee compensation and benefits totaled $1.4 million for the six months ended December 31, 2005, an increase of $857,000, or 159.6%, from the same period in 2004.  Such increase was due primarily to $555,000 in expense attributed to Frankfort First Federal combination, $93,000 attributed to expense of the Company’s ESOP plan, $35,000 attributable to awards made under the Equity Incentive Plan and normal salary increases.  Generally, other categories of operating expenses also experienced increases associated with the growth in operations due to the acquisition of Frankfort First.

Federal Income Taxes

The provision for federal income taxes totaled $435,000 for the six months ended December 31, 2005, an increase of $100,000, or 29.9%, compared to the same period in 2004.  This increase was due to an increase in earnings before taxes of $392,000, or 39.9%.  The effective tax rates were 31.6% and 34.1% for the six-month periods ended December 31, 2005 and 2004, respectively.  The difference between the 31.6% effective tax rate in 2005 and the 34% statutory tax rate is due primarily to tax-exempt earnings on bank-owned life insurance.

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Kentucky First Federal Bancorp

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

Comparison of Operating Results for the Three-Month Periods Ended December 31, 2005 and 2004

General

Net earnings totaled $449,000 for the three months ended December 31, 2005, an increase of $111,000, or 32.8% from the $338,000 in net earnings for the same period in 2004.  The increase was primarily attributable to a $758,000 increase in net interest income, coupled with an increase of $57,000 in other income, partially offset by an increase of $658,000 in general, administrative and other expense and an increase of $49,000 in the provision for federal income taxes.  As previously stated, the period to period increase in levels of operating income and expense are primarily attributable to the acquisition of Frankfort First in March 2005.

Net Interest Income

Interest income on loans increased by $1.7 million, or 295.2%, for the three months ended December 31, 2005, compared to the 2004 period.  This increase was due primarily to a $120.1 million, or 374.1%, increase in the average loan portfolio balance outstanding period to period offset by a 120 basis point decrease in the weighted-average yield, to 6.02% for the 2005 three-month period.  Income on other interest-earning assets increased by $27,000, or 3.1%, due primarily to a 75 basis point increase in the weighted-average yield, to 3.79% for the 2005 period despite a $5.1 million, or 5.2%, decrease in the average balance of the related assets outstanding period to period.  As set forth above, interest income was favorably influenced in the 2005 quarter by the addition of $115.0 million of interest-earning assets, that was a result of the acquisition of Frankfort First.

Interest expense on deposits increased by $542,000, or 119.4%, for the three months ended December 31, 2005, compared to the same period in 2004.  This increase was due primarily to a $54.4 million, or 55.4%, increase in the average balance of deposits outstanding period to period, generally reflecting the assumption of $72.5 million of average deposits in the Frankfort First combination.  The weighted average cost of deposits was 2.61% for the 2005 period and 1.85% for the 2004 period.  Interest expense on borrowings increased by $439,000, or 655.2%, due primarily to the assumption of $42.9 million of average FHLB advances in the Frankfort First combination.  The weighted average cost of borrowings increased 103 basis points to 4.01% for the 2005 period.

As a result of the foregoing changes in interest income and interest expense, net interest income increased by $758,000, or 81.9%, to a total of $1.7 million for the three months ended December 31, 2005.  Net interest margin decreased by 8 basis points to 2.73% for the three months ended December 31, 2005, compared to the prior year period.

Provision for Losses on Loans

The Company charges a provision for losses on loans to earnings to bring the total allowance for loan losses to a level considered appropriate by management based on historical experience, the volume and type of lending conducted by the Banks, the status of past due principal and interest payments, general economic conditions, particularly as such conditions relate to the Banks’ market areas and other factors related to the collectibility of the Banks’ loan portfolio. The Company recorded a provision for losses on loans totaling $10,000 during the three months ended December 31, 2005, a decrease of $3,000, or 23.1%, from the comparable three-month period in 2004.  There can be no assurance that the loan loss allowance will be adequate to absorb losses on known nonperforming loans or that the allowance will be adequate to cover losses on nonperforming assets in the future, which could adversely affect the Company’s results of operations.

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Kentucky First Federal Bancorp

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

Comparison of Operating Results for the Three-Month Periods Ended December 31, 2005 and 2004 (continued)

General, Administrative and Other Expense

General, administrative and other expense totaled $1.1 million for the three months ended December 31, 2005, an increase of $658,000, or 161.3%, compared to the same period in 2004.  This increase was due primarily to effects of the Frankfort First combination and the costs of operating a public company.  Employee compensation and benefits totaled $738,000 for the three months ended December 31, 2005, an increase of $465,000, or 170.3%, from the same period in 2004.  Such increase was due primarily to $213,000 in expense attributed to Frankfort First Federal combination, approximately $46,000 attributed to expense of the Company’s ESOP plan, $35,000 attributable to awards made under the Equity Incentive Plan and normal salary increases.  Generally, other categories of operating expenses also experienced increases associated with the growth in operations period to period.

Federal Income Taxes

The provision for federal income taxes totaled $222,000 for the three months ended December 31, 2005, an increase of $49,000, or 28.3%, compared to the same period in 2004.  The effective tax rates were 33.1% and 33.9% for the three-month periods ended December 31, 2005 and 2004, respectively.

ITEM 3:  Quantitative and Qualitative Disclosures About Market Risk

There has been no material change in the Company’s market risk since the disclosure included under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset and Liability Management” in the Company’s Form 10-K filed September 28, 2005.

ITEM 4:  Controls and Procedures

The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the Company’s disclosure controls and procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective.  During the quarterly period ended December 31, 2005, there were no changes in the Company’s internal control over financial reporting which materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

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Kentucky First Federal Bancorp

PART II

ITEM 1.	Legal Proceedings
	Not applicable.
ITEM 1A.	Risk Factors
	Not applicable.
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds
	The following table sets forth information regarding Company’s repurchases of its common stock during the quarter ended December 31, 2005.

Period		Total # of shares purchased			Average price paid per share			Total # of shares purchased as part of publicly announced plans or programs			Maximum # of shares that may yet be purchased under the plans or programs
October 1-31, 2005			—		$	—			—			168,486
November 1-30, 2005			—		$	—			—			168,486
December 1-31, 2005			78,800		$	10.55			78,800			89,686

	On December 14, 2005, the Company announced a program to repurchase up to 168,486 shares in order to fund awards of restricted stock under the Company’s 2005 Equity Incentive Plan.

ITEM 3.	Defaults Upon Senior Securities
	Not applicable.
ITEM 4.	Submission of Matters to a Vote of Security Holders
	(a)	The registrant held its Annual Meeting of Shareholders on November 15, 2005.
	(b)	Not applicable
	(c)	Three matters were voted upon at the Annual Meeting:
		1)	Election of two individuals as directors:

		Votes For			Votes Withheld
Walter G. Ecton, Jr.			8,033,327			88,954
Don D. Jennings			8,057,358			64,923

2)

Approval of the 2005 Equity Incentive Plan (excluding First Federal MHC):

Votes For		Votes Against		Votes Withheld
2,360,400		238,084		51,694

3)

Ratification of Grant Thornton, LLP, as the Company’s independent registered public accountants for the fiscal year ending June 30, 2006:

Votes For		Votes Against		Votes Withheld
8,088,282		16,283		17,716

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Kentucky First Federal Bancorp

PART II (CONTINUED)

ITEM 5.	Other Information
	None.
ITEM 6.	Exhibits

	31.1	CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	31.2	CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	32.1	CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
	32.2	CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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Kentucky First Federal Bancorp

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	KENTUCKY FIRST FEDERAL BANCORP
Date: February 14, 2006	By:	/s/Tony D. Whitaker
		Tony D. Whitaker
		Chairman of the Board and Chief Executive Officer
Date: February 14, 2006	By:	/s/R. Clay Hulette
		R. Clay Hulette
		Vice President and Chief Financial Officer

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