Kentucky First Federal Bancorp - Annual Report: 2007 (Form 10-K)

          Qualified Thrift Lender Test.  Federal law requires savings institutions to meet a qualified thrift lender test.  Under the test, a savings association is required to either qualify as a “domestic building and loan association” under the Internal Revenue Code or maintain at least 65% of its “portfolio assets” (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least 9 months out of each 12-month period.

          A savings institution that fails the qualified thrift lender test is subject to certain operating restrictions and may be required to convert to a bank charter.  Recent legislation has expanded the extent to which education loans, credit card loans and small business loans may be considered “qualified thrift investments.”  At June 30, 2007, First Federal of Hazard and First Federal of Frankfort each met the qualified thrift lender test.

          Transactions with Related Parties.  Federal law limits the authority of First Federal of Hazard and First Federal of Frankfort to lend to, and engage in certain other transactions with (collectively, “covered transactions”), “affiliates” (e.g., any company that controls or is under common control with an institution, including Kentucky First, First Federal MHC and their non-savings institution subsidiaries).  The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings institution.  The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings institution’s capital and surplus.  Loans and other specified transactions with affiliates are required to be secured by collateral in an amount and of a type described in federal law.  The purchase of low quality assets from affiliates from making loans is generally prohibited.  Transactions with affiliates must be on terms and under circumstances that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies.  In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.  Transactions between sister depository institutions that are 80% or more owned by the same holding company are exempt from the quantitative limits and collateral requirements.

          The Sarbanes-Oxley Act of 2002 generally prohibits a company from making loans to its executive officers and directors.  However, that act contains a specific exception for loans by a depository institution to its executive officers and directors in compliance with federal banking laws.  Under such laws, First Federal of Hazard’s and First Federal of Frankfort’s authority to extend credit to executive officers, directors and 10% shareholders (“insiders”), as well as entities such persons control, is limited.  The law restricts both the individual and aggregate amount of loans First Federal of Hazard and First Federal of Frankfort may make to insiders based, in part, on First Federal of Hazard’s and First Federal of Frankfort’s respective capital positions and requires certain board approval procedures to be followed.  Such loans must be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment.  There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees.  There are additional restrictions applicable to loans to executive officers.

          Enforcement.  The Office of Thrift Supervision has primary enforcement responsibility over federal savings institutions and has the authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution.  Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to appointment of a receiver or conservator or termination of deposit insurance.  Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases.  The Federal Deposit Insurance Corporation has authority to recommend to the Director of the Office of Thrift Supervision that enforcement action to be taken with respect to a particular savings institution.  If action is not taken by the Director, the Federal Deposit Insurance Corporation has authority to take such action under certain circumstances.  Federal law also establishes criminal penalties for certain violations.

          Assessments.  Federal savings banks are required to pay assessments to the Office of Thrift Supervision to fund its operations.  The general assessments, paid on a semi-annual basis, are based upon the savings institution’s total assets, including consolidated subsidiaries, as reported in the institution’s latest quarterly thrift financial report, its financial condition and the complexity of its portfolio.

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          Insurance of Deposit Accounts.  The Banks’ deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC.  The Deposit Insurance Fund is the successor to the Bank Insurance Fund and the Savings Association Insurance Fund, which were merged in 2006.  The FDIC recently amended its risk-based assessment system for 2007 to implement authority granted by the Federal Deposit Insurance Reform Act of 2005 (“Reform Act”).  Under the revised system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors.  An institution’s assessment rate depends upon the category to which it is assigned.  Risk category I, which contains the least risky depository institutions, is expected to include more than 90% of all institutions.  Unlike the other categories, Risk Category I contains further risk differentiation based on the FDIC’s analysis of financial ratios, examination component ratings and other information.  Assessment rates are determined by the FDIC and currently range from five to seven basis points for the healthiest institutions (Risk Category I) to 43 basis points of assessable deposits for the riskiest (Risk Category IV).  The FDIC may adjust rates uniformly from one quarter to the next, except that no single adjustment can exceed three basis points.  No institution may pay a dividend if in default of the FDIC assessment.

          The Reform Act also provided for a one-time credit for eligible institutions based on their assessment base as of December 31, 1996.  Subject to certain limitations with respect to institutions that are exhibiting weaknesses, credits can be used to offset assessments until exhausted.  First Federal of Hazard’s and First Federal of Frankfort’s one-time credits are expected to approximate $126,000 and $126,000, respectively.  The Reform Act also provided for the possibility that the FDIC may pay dividends to insured institutions once the Deposit Insurance Fund reserve ratio equals or exceeds 1.35% of estimated insured deposits.

          In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund.  This payment is established quarterly and during the calendar year ended June 30, 2007 averaged 1.24 basis points of assessable deposits.

          The Reform Act provided the FDIC with authority to adjust the Deposit Insurance Fund ratio to insured deposits within a range of 1.15% and 1.50%, in contrast to the prior statutorily fixed ratio of 1.25%.  The ratio, which is viewed by the FDIC as the level that the fund should achieve, was established by the agency at 1.25% for 2007. 

          The FDIC has authority to increase insurance assessments.  A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Banks.  Management cannot predict what insurance assessment rates will be in the future.

          Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.  Management does not know of any practice, condition or violation that might lead to termination of deposit insurance.

          Federal Home Loan Bank System.  First Federal of Hazard and First Federal of Frankfort are members of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks.  The Federal Home Loan Bank provides a central credit facility primarily for member institutions.  As members of the Federal Home Loan Bank of Cincinnati, First Federal of Hazard and First Federal of Frankfort are each required to acquire and hold shares of capital stock in that Federal Home Loan Bank.  First Federal of Hazard and First Federal of Frankfort were in compliance with this requirement with investments in Federal Home Loan Bank of Cincinnati stock at June 30, 2007, of $2.1 million and $3.3 million, respectively.

          Community Reinvestment Act.  Under the Community Reinvestment Act, as implemented by Office of Thrift Supervision regulations, a savings institution has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods.  The Community Reinvestment Act does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the Community Reinvestment Act.  The Community Reinvestment Act requires the Office of Thrift Supervision, in connection with its examination of a savings association, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution.

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          The Community Reinvestment Act requires public disclosure of an institution’s rating and requires the Office of Thrift Supervision to provide a written evaluation of an institution’s Community Reinvestment Act performance utilizing a four-tiered descriptive rating system.  First Federal of Hazard and First Federal of Frankfort each received a “Satisfactory” rating as a result of their most recent Community Reinvestment Act assessments.

Holding Company Regulation

          General.  Kentucky First and First Federal MHC are savings and loan holding companies within the meaning of federal law.  As such, they are registered with the Office of Thrift Supervision and are subject to Office of Thrift Supervision regulations, examinations, supervision, reporting requirements and regulations concerning corporate governance and activities.  In addition, the Office of Thrift Supervision has enforcement authority over Kentucky First and First Federal MHC and their non-savings institution subsidiaries.  Among other things, this authority permits the Office of Thrift Supervision to restrict or prohibit activities that are determined to be a serious risk to First Federal of Hazard and/or First Federal of Frankfort.

          Restrictions Applicable to Mutual Holding Companies.  According to federal law and Office of Thrift Supervision regulations, a mutual holding company, such as First Federal MHC, may generally engage in the following activities:  (1) investing in the stock of insured depository institutions and acquiring them by means of a merger or acquisition; (2) investing in a corporation the capital stock of which may be lawfully purchased by a savings association under federal law; (3) furnishing or performing management services for a savings association subsidiary of a savings and loan holding company; (4) conducting an insurance agency or escrow business; (5) holding, managing or liquidating assets owned or acquired from a savings association subsidiary of the savings and loan holding company; (6) holding or managing properties used or occupied by a savings association subsidiary of the savings and loan holding company; (7) acting as trustee under deed or trust; (8) any activity permitted for multiple savings and loan holding companies by Office of Thrift Supervision regulations; (9) any activity permitted by the Board of Governors of the Federal Reserve System for bank holding companies and financial holding companies; and (10) any activity permissible for service corporations.  Recent legislation, which authorized mutual holding companies to engage in activities permitted for financial holding companies, expanded the authorized activities.  Financial holding companies may engage in a broad array of financial services activities, including insurance and securities.

          Federal law prohibits a savings and loan holding company, including a federal mutual holding company, from directly or indirectly, or through one or more subsidiaries, acquiring more than 5% of the voting stock of another savings institution, or its holding company, without prior written approval of the Office of Thrift Supervision.  Federal law also prohibits a savings and loan holding company from acquiring or retaining control of a depository institution that is not insured by the Federal Deposit Insurance Corporation.  In evaluating applications by holding companies to acquire savings institutions, the Office of Thrift Supervision must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors.

          The Office of Thrift Supervision is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, except:  (1) the approval of interstate supervisory acquisitions by savings and loan holding companies, and (2) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions.  The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

          If a savings institution subsidiary of a savings and loan holding company fails to meet the qualified thrift lender test set, the holding company must register with the Federal Reserve Board as a bank holding company within one year of the savings institution’s failure to so qualify.

          Stock Holding Company Subsidiary Regulation.  The Office of Thrift Supervision has adopted regulations governing the two-tier mutual holding company form of organization and subsidiary stock holding companies that are controlled by mutual holding companies.  Kentucky First is the stock holding company subsidiary of First Federal MHC.  Kentucky First is only permitted to engage in activities that are permitted for First Federal MHC subject to the same restrictions and conditions.

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          Waivers of Dividends by First Federal MHC.  Office of Thrift Supervision regulations require First Federal MHC to notify the Office of Thrift Supervision if it proposes to waive receipt of our dividends from Kentucky First.  The Office of Thrift Supervision reviews dividend waiver notices on a case-by-case basis, and, in general, does not object to any such waiver if: (i) the waiver would not be detrimental to the safe and sound operation of the savings association; and (ii) the mutual holding company’s board of directors determines that such waiver is consistent with such directors’ fiduciary duties to the mutual holding company’s members. The Office of Thrift Supervision will not consider the amount of dividends waived by the mutual holding company in determining an appropriate exchange ratio in the event of a full conversion to stock form.  Kentucky First has been granted such a waiver.  Dividends paid to shareholders on November 20, 2006, February 16, May 21 and August 20, 2007 were waived by First Federal MHC.

          Conversion of First Federal MHC to Stock Form.  Office of Thrift Supervision regulations permit First Federal MHC to convert from the mutual form of organization to the capital stock form of organization.  In a conversion transaction, a new holding company would be formed as successor to First Federal MHC, its corporate existence would end, and certain depositors of First Federal of Hazard would receive the right to subscribe for additional shares of the new holding company. In a conversion transaction, each share of common stock held by stockholders other than First Federal MHC would be automatically converted into a number of shares of common stock of the new holding company based on an exchange ratio determined at the time of conversion that ensures that stockholders other than First Federal MHC own the same percentage of common stock in the new holding company as they owned in us immediately before conversion. Under Office of Thrift Supervision regulations, stockholders other than First Federal MHC would not be diluted because of any dividends waived by First Federal MHC (and waived dividends would not be considered in determining an appropriate exchange ratio), in the event First Federal MHC converts to stock form. The total number of shares held by stockholders other than First Federal MHC after a conversion transaction also would be increased by any purchases by stockholders other than First Federal MHC in the stock offering conducted as part of the conversion transaction.

          Acquisition of Control.  Under the federal Change in Bank Control Act, a notice must be submitted to the Office of Thrift Supervision if any person (including a company), or group acting in concert, seeks to acquire “control” of a savings and loan holding company or savings association.  An acquisition of “control” can occur upon the acquisition of 10% or more of the voting stock of a savings and loan holding company or savings institution or as otherwise defined by the Office of Thrift Supervision.  Under the Change in Bank Control Act, the Office of Thrift Supervision has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition.  Any company that so acquires control would then be subject to regulation as a savings and loan holding company.

          Remutualization Transactions.  Current Office of Thrift Supervision regulations permit a mutual holding company to be acquired by a mutual institution in a remutualization transaction.  However, the Office of Thrift Supervision has issued a policy statement indicating that it views remutualization transactions as raising significant issues concerning disparate treatment of minority stockholders and mutual members of the target entity and as raising issues concerning the effect on the mutual members of the acquiring entity.  Under certain circumstances, the Office of Thrift Supervision intends to give these issues special scrutiny and reject applications for the remutualization of a mutual holding company unless the applicant can clearly demonstrate that the Office of Thrift Supervision’s concerns are not warranted in the particular case.

Federal and State Taxation

          General.  We report our income on a fiscal year basis using the accrual method of accounting.

          Federal Taxation.  The federal income tax laws apply to us in the same manner as to other corporations with some exceptions, including particularly the reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to us.  Each of our federal income tax returns have been either audited or closed under the statute of limitations through tax year 2002. For the 2007 fiscal year, First Federal of Hazard’s and Frankfort First’s maximum federal income tax rate was 34%.

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          For fiscal years beginning before June 30, 1996, thrift institutions that qualified under certain definitional tests and other conditions of the Internal Revenue Code were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad debt reserve. A reserve could be established for bad debts on qualifying real property loans, generally secured by interests in real property improved or to be improved, under the percentage of taxable income method or the experience method. The reserve for nonqualifying loans was computed using the experience method.  Federal legislation enacted in 1996 repealed the reserve method of accounting for bad debts and the percentage of taxable income method for tax years beginning after 1995 and require savings institutions to recapture or take into income certain portions of their accumulated bad debt reserves.  First Federal of Hazard did not qualify for such favorable tax treatment for any years through 1996.  Approximately $5.4 million of First Federal of Frankfort First’s accumulated bad debt reserves would not be recaptured into taxable income unless Frankfort First makes a “non-dividend distribution” to Kentucky First as described below.

          If First Federal of Hazard or First Federal of Frankfort makes “non-dividend distributions” to us, the distributions will be considered to have been made from First Federal of Hazard’s and First Federal of Frankfort’s unrecaptured tax bad debt reserves, including the balance of their reserves as of December 31, 1987, to the extent of the “non-dividend distributions,” and then from First Federal of Frankfort’s supplemental reserve for losses on loans, to the extent of those reserves, and an amount based on the amount distributed, but not more than the amount of those reserves, will be included in First Federal of Frankfort’s taxable income.  Non-dividend distributions include distributions in excess of First Federal of Frankfort’s current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock, and distributions in partial or complete liquidation.  Dividends paid out of First Federal of Frankfort’s current or accumulated earnings and profits will not be so included in First Federal of Frankfort’s taxable income.

          The amount of additional taxable income triggered by a non-dividend is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Therefore, if First Federal of Frankfort makes a non-dividend distribution to us, approximately one and one-half times the amount of the distribution not in excess of the amount of the reserves would be includable in income for federal income tax purposes, assuming a 34% federal corporate income tax rate. First Federal of Frankfort does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserves.

          State Taxation.Although First Federal MHC and Kentucky First are subject to the Kentucky corporation income tax and state corporation license tax (franchise tax), the corporation license tax is repealed effective for tax periods ending on or after December 31, 2005.  Gross income of corporations subject to Kentucky income tax is similar to income reported for federal income tax purposes except that dividend income, among other income items, is exempt from taxation.  For First Federal MHC and Kentucky First tax years beginning July 1, 2005, the corporations are subject to an alternative minimum income tax.  Corporations must pay the greater of the income tax, the alternative tax or $175.  The corporations can choose between two methods to calculate the alternative minimum; 9.5 cents per $100 of the corporation’s gross receipts, or 75 cents per $100 of the corporation’s Kentucky gross profits.  Kentucky gross profits means Kentucky gross receipts reduced by returns and allowances attributable to Kentucky gross receipts, less Kentucky cost of goods sold.  The corporations, in their capacity as holding companies for financial institutions, do not have a material amount of cost of good sold.  Although the corporate license tax rate is 0.21% of total capital employed in Kentucky, a bank holding company, as defined in Kentucky Revised Statutes 287.900, is allowed to deduct from its taxable capital, the book value of its investment in the stock or securities of subsidiaries that are subject to the bank franchise tax.

          First Federal of Hazard and First Federal of Frankfort are exempt from both the Kentucky corporation income tax and corporation license tax.  However, both institutions are instead subject to the bank franchise tax, an annual tax imposed on federally or state chartered savings and loan associations, savings banks and other similar institutions operating in Kentucky.  The tax is 0.1% of taxable capital stock held as of January 1 each year.  Taxable capital stock includes an institution’s undivided profits, surplus and general reserves plus savings accounts and paid-up stock less deductible items.  Deductible items include certain exempt federal obligations and Kentucky municipal bonds.  Financial institutions which are subject to tax both within and without Kentucky must apportion their net capital.

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Item 1A.  Risk Factors

A significant percentage of the Banks’ assets is invested in lower yielding liquid investments.  Our inability to reinvest these assets into higher yielding assets, such as loans, will continue to hinder our ability to be more profitable.

          The reinvestment of our assets into higher yielding assets, such as loans, is contingent upon loan demand remaining somewhat strong.   During the fiscal year ended June 30, 2007, we were successful in reinvesting funds into new loans.  Our loan balances increased by $10.8 million year to year, funded by a $4.0 million reduction in cash and cash equivalents and securities.  The balance of the loan growth was funded primarily by short-term FHLB Advances, which may be repaid with cash flows from investments.  However, for this trend to continue the banks must continue to originate mortgages, which could prove more difficult as various troubles in the real estate market reduce buyers in the market.  However, the Company may benefit from other recent developments in the market, such as less competition from mortgage brokers and improved profitability in the rental housing market (also a significant source of loans for the Company).  If the Company is unable to reinvest the cash flows from lower yielding investments into higher yielding assets, such as loans, or repay higher costing funding sources, then our net interest income could continue to suffer.  

We may not be able to achieve sufficient growth in our retail franchise to allow us to achieve the anticipated benefits of our merger with Frankfort First Bancorp.

          We intend to efficiently utilize excess liquidity at either Bank or Kentucky First by buying and selling whole loans or participations in loans between First Federal of Hazard and First Federal of Frankfort, with the originating bank retaining servicing of any loans sold, or by making deposits into accounts at either bank, subject to regulatory limitations, in order to maximize the potential earnings of each bank.  This strategy will not succeed if we do not maintain sufficient loan demand at First Federal of Frankfort or sufficient deposit growth at First Federal of Hazard.  At June 30, 2007, Frankfort First had total real estate loans of $117.6 million, compared to $118.8 million at June 30, 2006, a decrease of approximately $1.2 million, or 1.0%.  Loans sold by First Federal of Frankfort to First Federal of Hazard were $21.4 million and $8.9 million at June 30, 2007 and 2006, respectively.  At June 30, 2007, Federal of Hazard had total deposits of $84.4 million, compared to total deposits of $81.9 million at June 30, 2006, an increase of $2.5 million, or 3.1%.  There can be no assurance as to if or when this strategy can be accomplished.  In an attempt to increase the overall interest rate spread of the combined company, management may adopt strategies that result in decreases in the assets and/or liabilities of either or both Banks. 

Rising interest rates may hurt our profits and asset values.

          If interest rates continue to rise, our net interest income would likely decline in the short term since, due to the generally shorter terms of interest-bearing liabilities, interest expense paid on interest-bearing liabilities,  increases more quickly than interest income earned on interest-earning assets, such as loans and investments.   In addition, a continuation of rising interest rates may hurt our income because of reduced demand for new loans, the demand for refinancing loans and the interest and fee income earned on new loans and refinancings.  At June 30, 2007, in the event of an instantaneous and permanent 200 basis point increase in interest rates, our net portfolio value, which represents the discounted present value of the difference between incoming cash flows on interest-earning and other assets and outgoing cash flows on interest-bearing liabilities, would be expected to decrease by approximately 16%.  While we believe that modest interest rate increases will not significantly hurt our interest rate spread over the long term due to our high level of liquidity and the presence of a significant amount of adjustable-rate mortgage loans in our loan portfolio, interest rate increases may initially reduce our interest rate spread until such time as our loans and investments reprice to higher levels.

          Changes in interest rates also affect the value of our interest-earning assets, and in particular our securities portfolio.  Generally, the value of fixed-rate securities fluctuates inversely with changes in interest rates.  Unrealized gains and losses on securities available for sale are reported as separate components of equity.  Decreases in the fair value of securities available for sale resulting from increases in interest rates therefore could have an adverse effect on stockholders’ equity.

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Strong competition within our market area could hurt our profits and slow growth.

          Although we consider ourselves competitive in our market areas, we face intense competition both in making loans and attracting deposits.  Price competition for loans and deposits might result in our earning less on our loans and paying more on our deposits, which reduces net interest income.  Some of the institutions with which we compete have substantially greater resources than we have and may offer services that we do not provide.  We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry.  Our profitability will depend upon our continued ability to compete successfully in our market areas. 

The distressed economy in First Federal of Hazard’s market area could hurt our profits and slow our growth.

          First Federal of Hazard’s market area consists of Perry and surrounding counties in eastern Kentucky.  The economy in this market area has been distressed in recent years due to the decline in the coal industry on which the economy has been dependent.  While there has been improvement in the economy from the influx of other industries, such as health care and manufacturing, and there may be signs that the coal industry is improving with the rising costs of petroleum, the economy in First Federal of Hazard’s market area continues to lag behind the economies of Kentucky and the United States.  As a result, First Federal of Hazard has experienced insufficient loan demand in its market area.  While First Federal of Hazard will seek to use excess funds to purchase loans from First Federal of Frankfort, we expect the redeployment of funds from securities into loans to take several years.  Moreover, the slow economy in First Federal of Hazard’s market area will limit our ability to grow our asset base in that market.

We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations.

          We are subject to extensive government regulation, supervision and examination.  Such regulation, supervision and examination govern the activities in which we may engage, and is intended primarily for the protection of the deposit insurance fund and our depositors.  Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses.  Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations.

We expect that our return on equity will be low compared to other companies as a result of our recently completed public offering.

          Return on average equity, which equals net income divided by average equity, is a ratio used by many investors to compare the performance of a particular company with other companies. For the year ended June 30, 2007, our return on average equity was 1.41%.  Over time, we intend to leverage our capital by continued investment in higher-yielding assets, such as loans.  We also intend to continue managing excess capital through our stock repurchase program, which has been successful, given relatively low market prices of the Company’s common stock.  However, this program could be curtailed or rendered less effective if the market price of our stock increases, or if the Company’s liquid funds are deployed elsewhere.  Our goal of generating a return on average equity that is competitive with other publicly-held subsidiaries of mutual holding companies, by increasing earnings per share and book value per share, without assuming undue risk, could take a number of years to achieve, and we cannot assure that our goal will be attained.  Consequently, you should not expect a competitive return on average equity in the near future.  Failure to achieve a competitive return on average equity might make an investment in our common stock unattractive to some investors and might cause our common stock to trade at lower prices than comparable companies with higher returns on average equity.

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Additional annual employee compensation and benefit expenses may reduce our profitability and stockholders’ equity.

          We will continue to recognize employee compensation and benefit expenses for employees and executives under our benefit plans.  With regard to  the employee stock ownership plan, applicable accounting practices require that the expense be based on the fair market value of the shares of common stock at specific points in the future, therefore we will recognize expenses for our employee stock ownership plan when shares are committed to be released to participants’ accounts.  We will also recognize expenses for restricted stock awards and options over the vesting periods of those awards.  In addition, employees of both subsidiary Banks participate in a defined-benefit plan through Pentegra.  Costs associated with the defined-benefit plans could increase or legislation could be enacted that would increase the Banks’ obligations under the plan or change the methods the Banks use in accounting for the plans.  Those changes could adversely affect personnel expense and the Company’s balance sheet.

First Federal MHC owns a majority of our common stock and is able to exercise voting control over most matters put to a vote of stockholders, including preventing sale or merger transactions you may like or a second-step conversion by First Federal MHC.

          First Federal MHC owns a majority of our common stock and, through its Board of Directors, is able to exercise voting control over most matters put to a vote of stockholders.  As a federally chartered mutual holding company, the board of directors of First Federal MHC must ensure that the interests of depositors of First Federal of Hazard are represented and considered in matters put to a vote of stockholders of Kentucky First.  Therefore, the votes cast by First Federal MHC may not be in your personal best interests as a stockholder.  For example, First Federal MHC may exercise its voting control to prevent a sale or merger transaction in which stockholders could receive a premium for their shares, prevent a second-step conversion transaction by First Federal MHC or defeat a stockholder nominee for election to the Board of Directors of Kentucky First.  However, implementation of a stock-based incentive plan will require approval of Kentucky First’s stockholders other than First Federal MHC.  In addition, Office of Thrift Supervision regulations prohibit, for three years following the completion of our public offering, the acquisition of more than 10% of any class of equity security of the company without the prior approval of the Office of Thrift Supervision.  Even after this three-year period, Office of Thrift Supervision regulations would likely prevent an acquisition of Kentucky First other than by another mutual holding company or a mutual institution.

There may be a limited market for our common stock which may lower our stock price.

          Although our shares of common stock are listed on the Nasdaq Global Market, there is no guarantee that the shares will be regularly traded.  If an active trading market for our common stock does not develop, you may not be able to sell all of your shares of common stock on short notice and the sale of a large number of shares at one time could temporarily depress the market price.

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Item 1B.  Unresolved Staff Comments

None.

Item 2.  Properties

          We conduct our business through four offices.  The following table sets forth certain information relating to our offices at June 30, 2007.

		Year Opened/Acquired			Owned or Leased			Net Book Value at June 30, 2007			Approximate Square Footage
		(Dollars in thousands)
First Federal of Hazard			1960			Owned		$	—			15,000
Main Office:
479 Main Street
Hazard, Kentucky 41701
First Federal of Frankfort			2005			Owned		$	1,407			14,000
Main Office:
216 West Main Street
Frankfort, Kentucky 40601
East Branch			2005			Owned		$	551			1,800
1980 Versailles Road
Frankfort, Kentucky 40601
West Branch			2005			Owned		$	530			2,480
1220 US 127 South
Frankfort, Kentucky 40601

          The net book value of our investment in premises and equipment was $2.8 million at June 30, 2007.  See Note E of Notes to Consolidated Financial Statements.

Item 3.  Legal Proceedings

          From time to time, we may be defendants in claims and lawsuits against us, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business.  We are not a party to any pending legal proceedings that we believe could have a material adverse effect on our financial condition, results of operations or cash flows.

Item 4.  Submission of Matters to a Vote of Security Holders

          Not applicable.

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PART II

Item 5.  Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

          (a)     The information contained under the sections captioned “Market Information” in the Company’s Annual Report to Stockholders for the Fiscal Year Ended June 30, 2007 (the “Annual Report”) filed as Exhibit 13 hereto is incorporated herein by reference.

          (b)     Not applicable.

          (c)     The Company repurchased the following equity securities registered under the Securities Exchange Act of 1934, as amended, during the fourth quarter of the fiscal year ended June 30, 2007.

Period		(a) Total Number of Shares Purchased			(b) Average Price Paid per Share			(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs			(d) Maximum Number of Shares That May Yet Be Purchased Under the Plans or Programs (1)
April 2007			28,000		$	10.16			28,000			96,000
Beginning date: April 1
Ending date:  April 30
May 2007			27,500		$	10.14			27,500			68,500
Beginning date: May 1
Ending date:  May 31
June 2007			28,500		$	10.15			28,500			40,000
Beginning date: June 1
Ending date: June 30
Total			84,000		$	10.15			84,000			40,000

(1)	On March 13, 2007, the Company announced a program to repurchase up to 150,000 shares of its Common Stock.  This program was completed on August 17, 2007 when the Company completed the repurchase of substantially all shares authorized under this program and on that same date announced another program to repurchase up to 150,000 shares of its Common Stock.

Item 6.  Selected Financial Data

          The information contained in the table captioned “Selected Consolidated Financial and Other Data” in the Annual Report is incorporated herein by reference.

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

          The information contained in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report is incorporated herein by reference.

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

          The information contained under the sections captioned “Market Risk” in the Annual Report is incorporated herein by reference.

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Item 8.  Financial Statements and Supplementary Data

          The Consolidated Financial Statements, Notes to Consolidated Financial Statements, Independent Auditor’s Report and Selected Financial Data, which are listed under Item 15 herein, are included in the Annual Report and are incorporated herein by reference.

Item 9.  Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

          None.

Item 9A.  Controls and Procedures

          As of the end of the period covered by this report, management of the Company carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.  It should be noted that the design of the Company’s disclosure controls and procedures is based in part upon certain reasonable assumptions about the likelihood of future events, and there can be no reasonable assurance that any design of disclosure controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote, but the Company’s principal executive and financial officers have concluded that the Company’s disclosure controls and procedures are, in fact, effective at a reasonable assurance level.

          There have been no changes in the Company’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Securities and Exchange Commission Rule 13a-15 that occurred during the Company’s last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Item 9B.  Other Information

          Not Applicable.

PART III

Item 10.  Directors and Executive Officers of the Registrant

          The information contained under the sections captioned “Proposal I -- Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s definitive proxy statement for the Company’s 2007 Annual Meeting of Stockholders (the “Proxy Statement”) is incorporated herein by reference.

          Kentucky First has adopted a Code of Ethics and Business Conduct that applies to all of its directors, officers and employees.  To obtain a copy of this document at no charge, please write to Kentucky First Federal Bancorp, P.O. Box 535, Frankfort, Kentucky 40602-0535, or call toll-free (888) 818-3372 and ask for Investor Relations.

Item 11.  Executive Compensation

          The information contained under the section captioned “Proposal I -- Election of Directors -- Executive Compensation,” in the Proxy Statement is incorporated herein by reference.

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Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

	(a)	Security Ownership of Certain Beneficial Owners.  Information required by this item is incorporated herein by reference to the section captioned “Voting Securities and Security Ownership” in the Proxy Statement.
	(b)	Security Ownership of Management.  Information required by this item is incorporated herein by reference to the sections captioned “Voting Securities and Security Ownership” and “Proposal I -- Election of Directors” in the Proxy Statement.
	(c)	Changes in Control.  Management of the Company knows of no arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the Company.
	(d)	Equity Compensation Plans.  The following table sets forth certain information with respect to the Company’s equity compensation plans as of June 30, 2007.

		(a)			(b)			(c)
		Number of securities to be issued upon exercise of outstanding options, warrants and rights			Weighted-average exercise price of outstanding options, warrants and rights			Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plans approved by security holders			339,200		$	10.10			82,016
Equity compensation plans not approved by security holders			—			—			—
Total			339,200		$	10.10			82,016

Item 13.  Certain Relationships and Related Transactions

          The information required by this item is incorporated herein by reference to the section captioned “Proposal I -- Election of Directors -- Transactions with Management” in the Proxy Statement.

Item 14.  Principal Accountant Fees and Services

          The information required by this item is incorporated herein by reference to the section captioned “Audit and Other Fees Paid to Independent Registered Public Accountants” in the Proxy Statement.

PART IV

Item 15.  Exhibits and Financial Statement Schedules

(a)  List of Documents Filed as Part of This Report

(1)

Financial Statements.  The following consolidated financial statements are incorporated by reference from Item 8 hereof (see Exhibit 13):

Report of Independent Registered Public Accounting Firm

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	Consolidated Statements of Financial Condition as of June 30, 2007 and 2006
	Consolidated Statements of Earnings for the Years Ended June 30, 2007, 2006 and 2005
	Consolidated Statements of Shareholders’ Equity and Comprehensive Income for the Years Ended June 30, 2007, 2006 and 2005
	Consolidated Statements of Cash Flows for the Years Ended June 30, 2007, 2006 and 2005
	Notes to Consolidated Financial Statements

(2)	Financial Statement Schedules.  All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are omitted because of the absence of conditions under which they are required or because the required information is included in the consolidated financial statements and related notes thereto.
(3)	Exhibits.  The following is a list of exhibits filed as part of this Annual Report on Form 10-K and is also the Exhibit Index.

No.	Description
3.1	Charter of Kentucky First Federal Bancorp*
3.2	Bylaws of Kentucky First Federal Bancorp*
4.1	Specimen Stock Certificate of Kentucky First Federal Bancorp*
10.1	Form of First Federal Savings and Loan Association of Hazard Employee Stock Ownership Plan and Trust Agreement*†
10.2	Form of ESOP Loan Documents*†
10.3	Form of Employment Agreement between Kentucky First Federal Bancorp, First Federal Savings Bank of Frankfort and Don D. Jennings*†
10.4	Form of Employment Agreement between Kentucky First Federal Bancorp, First Federal Savings Bank of Frankfort and R. Clay Hulette*†
10.5	Form of Employment Agreement between First Federal Savings Bank of Frankfort and Danny A. Garland*†
10.6	Form of Employment Agreement between First Federal Savings Bank of Frankfort and Teresa Kuhl*†
10.7	Form of Employment Agreement between Kentucky First Federal Bancorp, First Federal Savings and Loan Association of Hazard and Tony D. Whitaker*†
10.8	Form of First Federal Savings and Loan Association of Hazard Supplemental Executive Retirement Plan*†
10.9	Form of First Federal Savings and Loan Association of Hazard Change in Control Severance Compensation Plan*†
10.10	Form of First Federal Savings Bank of Frankfort Change in Control Severance Compensation Plan*†
13	Annual Report to Stockholders
21	Subsidiaries
23.1	Consent of BKD LLP
23.2	Consent of Grant Thornton LLP
31.1	Rule 13a-14(a) Certification of Chief Executive Officer
31.2	Rule 13a-14(a) Certification of Chief Financial Officer
32	Section 1350 Certifications

†	Management contract or compensation plan or arrangement.
*	Incorporated herein by reference to the Company’s Registration Statement on Form S-1 (File No. 333-119041).

(b)	Exhibits.  The exhibits required by Item 601 of Regulation S-K are either filed as part of this Annual Report on Form 10-K or incorporated by reference herein.
(c)	Financial Statements and Schedules Excluded from Annual Report.  There are no other financial statements and financial statement schedules which were excluded from the Annual Report to Stockholders pursuant to Rule 14a-3(b) which are required to be included herein.

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SIGNATURES

          Pursuant to the requirements of Section 13 or 15(d) 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
September 28, 2007	By:	/s/ Tony D. Whitaker
		Tony D. Whitaker
		Chief Executive Officer

          Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

/s/ Tony D. Whitaker		September 28, 2007
Tony D. Whitaker
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
/s/ R. Clay Hulette		September 28, 2007
R. Clay Hulette
Vice President, Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
/s/ Don D. Jennings		September 28, 2007
Don D. Jennings
Director
/s/ Stephen G. Barker		September 28, 2007
Stephen G. Barker
Director
/s/ William D. Gorman		September 28, 2007
William D. Gorman
Director
/s/ Walter G. Ecton, Jr.		September 28, 2007
Walter G. Ecton, Jr.
Director
/s/ David R. Harrod		September 28, 2007
David R. Harrod
Director
/s/ Herman D. Regan, Jr.		September 28, 2007
Herman D. Regan, Jr.
Director