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

Kentucky First Federal Bancorp

NOTES TO FINANCIAL STATEMENTS

For the three-month periods ended September 30, 2005 and 2004

On July 14, 2004, the Board of Directors of the First Federal Savings and Loan Association (“First Federal of Hazard” or the “Association”) adopted a Plan of Reorganization (the “Plan” or the “Reorganization”) pursuant to which the Association would reorganize into the mutual holding company form of ownership with the incorporation of a stock holding company, Kentucky First Federal Bancorp (the “Company”) as parent of the Association.  Coincident with the Reorganization, the Association would convert to the stock form of ownership, followed by the issuance of all the Association’s outstanding stock to Kentucky First Federal Bancorp.  On March 2, 2005, the Plan of Reorganization was completed with Kentucky First Federal Bancorp issuing 4,727,938 common shares, or 55% of its common shares, to First Federal Mutual Holding Company (“First Federal MHC”), a federally chartered mutual holding company, with 2,127,572 common shares, or 24.8% of its shares offered for sale at $10.00 per share to the public and a newly formed Employee Stock Ownership Plan (“ESOP”).  The Company received net cash proceeds of $16.1 million from the public sale of its common shares.  The Company’s remaining 1,740,554 common shares were issued as part of the $31.4 million cash and stock consideration paid for 100% of the common shares of Frankfort First Bancorp (“Frankfort First”) and its wholly-owned subsidiary, Frankfort First Federal Savings Bank (“Frankfort First Federal”).  The acquisition was accounted for using the purchase method of accounting and resulted in the recordation of goodwill and other intangible assets totaling $15.4 million.  In accordance with the purchase method of accounting, the Company’s results of operations and cash flows for the three-month period ended September 30, 2004 do not reflect Frankfort First’s operating results.

1.     Basis of Presentation

The accompanying unaudited consolidated financial statements, which represent the consolidated financial condition and results of operations of the Company, were prepared in accordance with the instructions for Form 10-Q and, therefore, do not include information or footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America.  However, in the opinion of management, all adjustments (consisting of only normal recurring accruals) which are necessary for a fair presentation of the consolidated financial statements have been included.  The results of operations for three-month period ended September 30, 2005, are not necessarily indicative of the results which may be expected for the entire fiscal year.

2.     Principles of Consolidation

The consolidated financial statements include the accounts of the Company, Frankfort First, and its wholly-owned banking subsidiaries, First Federal of Hazard and Frankfort First Federal (collectively hereinafter “the Banks”).  All intercompany transactions and balances have been eliminated in consolidation.

3.     Critical Accounting Policies

We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies.  We consider the allowance for loan losses to be a critical accounting policy.

The allowance for loan losses is the estimated amount considered necessary to cover probable incurred credit losses in the loan portfolio at the balance sheet date.  The allowance is established through the provision for losses on loans which is charged against income.  In determining the allowance for loan losses, management makes significant estimates and has identified this accounting policy as one of the most critical for the Company.

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Kentucky First Federal Bancorp

NOTES TO FINANCIAL STATEMENTS

For the three-month periods ended September 30, 2005 and 2004

3.     Critical Accounting Policies (continued)

Management of the Banks perform a monthly evaluation of the allowance for loan losses.  Consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal loan reviews, volume and mix of the loan portfolio and other relevant factors.  This evaluation is inherently subjective as it requires material estimates that may be susceptible to change.  Management considers the economic climate in the lending areas to be among the factors most likely to have an impact on the level of the required allowance for loan losses.  However, in view of the fact that the Banks’ local economies are diverse, without significant dependence on a single industry or employer, the economic climate in the Banks’ market areas are considered to be stable, and improving.  Nevertheless, management continues to monitor and evaluate factors which could have an impact on the required level of the allowance.  Nationally, management will watch for issues that may negatively affect a significant percentage of homeowners in the Banks’ lending areas.  These may include significant increases in unemployment or significant depreciation in home prices.  Management reviews employment statistics periodically when determining the allowance for loan losses and generally finds the unemployment rate in the Banks’ lending areas to be acceptable in relation to historical trends. Given the aforementioned indicators of economic stability, management does not foresee in the near term, any significant increases in the required allowance for loan losses related to economic factors.  Finally, Company management has no current plans to alter the type of lending offered or collateral accepted by the Banks, but if such plans change or market conditions result in large concentrations of certain types of loans, such as commercial real estate or high loan-to-value ratio residential loans, management would respond with an increase in the overall allowance for loan losses.

The allowance for loan losses analysis has two components, specific and general allocations.  Specific allocations are made for loans that are determined to be impaired.  Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses.  The general allocation is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history.  Historical loss experience, delinquency trends, general economic conditions and geographic and industry concentrations are also analyzed.  This analysis establishes factors that are applied to the loan groups to determine the amount of the general reserve.  Actual loan losses may be significantly more than the allowance established, which could have a material negative effect on the Company’s consolidated financial results.

4.     Earnings Per Share

Basic earnings per share for the three month period ended September 30, 2005, was $0.06.  Basic earnings per share for the three month period ended September 30, 2004, is not presented as the Company was not a stock entity for the entire period.

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Kentucky First Federal Bancorp

NOTES TO FINANCIAL STATEMENTS

For the three-month periods ended September 30, 2005 and 2004

5.     Recent Accounting Pronouncements

During December 2004, the Financial Accounting Standards Board (the “FASB”) issued a revision to Statement of Financial Accounting Standards No. 123  (“SFAS 123(R)”), “Share-Based Payment,” which establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, primarily on accounting for transactions in which an entity obtains employee services in share-based transactions.  This Statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award, with limited exceptions.  That cost will be recognized over the period during which an employee is required to provide services in exchange for the award – the requisite service period.  No compensation cost is recognized for equity instruments for which employees do not render the requisite service.  Employee share purchase plans will not result in recognition of compensation cost if certain conditions are met.

Initially, the cost of employee services received in exchange for an award of liability instruments will be measured based on current fair value; the fair value of that award will be remeasured subsequently at each reporting date through the settlement date.  Changes in fair value during the requisite service period will be recognized as compensation cost over that period.  The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models, adjusted for the unique characteristics of those instruments (unless observable market prices for the same or similar instruments are available).  If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification.

Excess tax benefits, as defined by SFAS 123(R) will be recognized as an addition to additional paid-in capital.  Cash retained as a result of those excess tax benefits will be presented in the statement of cash flows as financing cash inflows.  The write-off of deferred tax assets relating to unrealized tax benefits associated with recognized compensation cost will be recognized as income tax expense, unless there are excess tax benefits from previous awards remaining in additional paid-in capital to which it can be offset.

Compensation cost is required to be recognized in the first interim or annual period that begins after June 15, 2005, or July 1, 2005 as to the Company.  Although the Company currently has no stock option plans or other instruments that are subject to the provisions of SFAS No. 123(R), shareholders are scheduled to vote on the adoption of the  Kentucky First Federal Bancorp 2005 Equity Incentive Plan at the  Annual Meeting of Shareholders on November 15, 2005.

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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 September 30, 2005

Assets:  At September 30, 2005, the Company’s assets totaled $271.7 million, a decrease of $2.2 million, or 0.8%, from total assets at June 30, 2005.  The primary reason for the decrease in assets is the decrease of $1.0 million, or 4.7%, of mortgage-backed securities classified as held to maturity, which decreased to $20.3 million at September 30, 2005. Also contributing to the decrease in total assets was a decrease in cash and cash equivalents which decreased $571,000 or 6.8% to $7.8 million at September 30, 2005.

Non-Performing Assets:  At September 30, 2005, the Company had approximately $1.9 million (1.2% of net loans) in loans 90 days or more past due, as compared to $1.7 million at June 30, 2005.  At September 30, 2005, the Company’s allowance for loan losses of $593,000 represented 30.8% of nonperforming loans and 0.4% of total loans. 

The Company had $2.0 million in loans classified as substandard for regulatory purposes at September 30, 2005.  On a percentage basis, classified loans remained consistent at 1.3% of total loans at September 30, 2005 and June 30, 2005.   Substandard assets included 41 single-family home loans with loan-to-value ratios (percentage of loan balance to the original or an updated appraisal) ranging from 5% to 95%; 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%; and two single-family homes, which comprise Real Estate Owned (which had a fair value of $60,000).

At September 30, 2005, no loans were classified as Doubtful or Loss.

Liabilities:  At September 30, 2005, the Company’s liabilities totaled $205.8 million, a decrease of $2.2 million, or 1.1%, from total liabilities at June 30, 2005.  The decrease in liabilities was attributed primarily to a $2.2 million or 1.4% decrease in deposits, which declined to $152.9 million at September 30, 2005, and a $356,000, or 0.7%, decrease in Advances from the Federal Home Loan Bank, which declined to $50.6 million at September 30, 2005.

Shareholders’ Equity: At June 30, 2005 and September 30, 2005, the Company’s shareholders’ equity totaled $65.9 million.

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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 September 30, 2005 and 2004

General

Net earnings totaled $491,000 for the three months ended September 30, 2005, an increase of $181,000, or 58.4% from the $310,000 in net earnings for the same period in 2004.  The increase was primarily attributable to an $800,000 increase in net interest income offset by an increase of $623,000 in general, administrative and other expense and an increase of $51,000 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 $1.7 million, or 281.2%, for the three months ended September 30, 2005, compared to the 2004 period.  This increase was due primarily to a $117.8 million, or 350.2%, increase in the average portfolio balance outstanding period to period offset by an 81 basis point decrease in the weighted-average yield, to 6.04% for the 2005 three-month period.  Interest income on investment securities, mortgage-backed securities and interest-bearing deposits increased by $88,000, or 10.6%, due primarily to a 216 basis point increase in the weighted-average yield, to 2.11% for the 2005 period despite a $5.0 million, or 4.8%, 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 $112.8 million of interest-earning assets.

Interest expense on deposits increased by $466,000, or 95.7%, for the three months ended September 30, 2005, compared to the same period in 2004.  This increase was due primarily to a $58.7 million, or 59.1%, 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 2.41% for 2005 period and 1.95% for the 2004 period.  Interest expense on borrowings increased by $509,000, or 759.7%, 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 4.25% for the 2005 period.

As a result of the foregoing changes in interest income and interest expense, net interest income increased by $800,000, or 91.0%, to a total of $1.7 million for the three months ended September 30, 2005.  Net interest margin increased by 11 basis points to 2.67% for the three months ended September 30, 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 $14,000 during the three months ended September 30, 2005, a decrease of $1,000, or 6.7%, 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 September 30, 2005 and 2004 (continued)

Other Income

Other income totaled $59,000 for the three months ended September 30, 2005, an increase of $54,000, or 1080.0%, from the same period in 2004.  The increase in the 2005 quarter is generally attributable to $20,000 of earnings on bank-owned life insurance and $17,000 in gain on sale of loans.

General, Administrative and Other Expense

General, administrative and other expense totaled $1.0 million for the three months ended September 30, 2005, an increase of $623,000, or 156.9%, 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 $656,000 for the three months ended September 30, 2005, an increase of $392,000, or 148.5%, from the same period in 2004.  Such increase was due primarily to normal merit increases, $289,000 in expense attributed to Frankfort First Federal combination and $46,000 attributed to expense of the Company’s ESOP plan.  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 $213,000 for the three months ended September 30, 2005, an increase of $51,000, or 31.5%, compared to the same period in 2004.  This increase was due to an increase in earnings before taxes of $232,000, or 49.2%.  The effective tax rates were 30.3% and 34.3% for the three-month periods ended September 30, 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 Association’s Form S-1 filing dated January 10, 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 September 30, 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 2.		Unregistered Sales of Equity Securities and Use of Proceeds
		Not applicable.
ITEM 3.		Defaults Upon Senior Securities
		Not applicable.
ITEM 4.		Submission of Matters to a Vote of Security Holders
		None.
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:  November    14, 2005	By:	/s/ Tony D. Whitaker
		Tony D. Whitaker
		Chairman of the Board and Chief Executive Officer
Date:  November    14, 2005	By:	/s/ R. Clay Hulette
		R. Clay Hulette
		Vice President and Chief Financial Officer

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